January 30, 2018

ETF Capital Markets Desk: Investors’ Love Affair with ETFs and other Trends to Watch in 2018

David Mann

David MannHead of Capital Markets, Global Exchange-Traded Funds (ETFs), Franklin Templeton Investments

As equities soared across the globe in 2017, investors’ love affair with exchange-traded funds (ETFs) also showed few signs of stopping. David Mann, head of Capital Markets, Global ETFs, shares his thoughts on why he feels assets might continue to pour into ETFs, along with other industry trends he sees.

Now that I am done reviewing my predictions from 2017, we can get on with the business of taking some stabs at what may happen in the ETF industry in 2018. If last year is any guide, some of my predictions will hit the mark, but others maybe not so much. Great hook to have you keep reading, right?

This year, I am going to go with three predictions. Feel free to comment on these or share some of your own on our Twitter feed, @LibertyShares.

1. Active equity ETFs will make a surprising asset leap

I have talked about fully transparent active ETFs on this blog on several occasions. To summarize the main points in a few words, structurally the only difference between active ETFs and index ETFs are that the active ETFs do not track an index. All the other potential ETF benefits remain the same, which is why the slow adoption has been a real head-scratcher at times.

Last year we saw $14 billion go into active ETFs industrywide in the United States, leading to an increase in assets under management (AUM) of almost 50%.1 It should be noted that the majority of those assets were in active fixed income ETFs. I think this year, the equity ETFs will have their day in the sun. Many active equity funds will have hit their track-record milestones (i.e., one-year or three-year), which will make it easier to discuss performance.  Also, as more and more funds are launched that track somewhat niche indexes, the index-tracking characteristic becomes less relevant than understanding the motivation behind the index construction.

2. The interest in low-cost passive ETFs is not going to change

We have seen an incredible run for global equity markets over the past year, with many currently at or near all-time highs. Investors responded by pouring just under a half trillion dollars into ETFs in the United States alone, with almost half of those assets (49%) into funds with an expense ratio of 10 basis points (bps) or less.2

In my view, it’s very possible this trend will continue, particularly now that there are so many more low-cost options in this space, including a growing list of new niches. Beyond the biggest low-cost ETFs that hold US equities, investors can now get exposure to countries including Japan, Germany and South Korea for single-digit expense ratios as well.

I am not in the business of making predictions on what price major indexes will finish 2018 with, but I feel pretty confident about this one, no matter what the markets decide to do this year.

 3. More Niche Areas

In addition to ETFs focused on different asset classes, countries and regions, we’ve seen a proliferation of ETFs in the United States and abroad focused on a variety of niche areas. These are incredibly specialized thematic plays, for example, social media companies or those which promote gender diversity. One big area of focus, particularly outside the United States, is not only in “socially conscious” investing, but also incorporating the principles of positive environmental, social and governance (ESG) characteristics. I think we’ll likely see more of the niche types of ETFs, but I’m not sure they will all ultimately survive.

4. Possible ETF-related regulations

Yes, I am getting back on the ETF regulatory horse one last time (at least for now). There are two main ETF-related possible regulations I will be monitoring.

The first is the potential for an ETF rule. I wrote about the rule in my 2017 predictions, so I will not rehash that one here in detail. But in a nutshell, a potential industry-wide “ETF rule” would aim to set standards for all ETF issuers regarding their creation/redemption practices as well as the liquidity and diversification required of its underlying basket of securities.

The second issue on the regulatory front is the potential for allowing direct payments for market-making (also known as Rule 5250). You can find that notice with more details here:  http://www.finra.org/industry/notices/17-41.

Currently, FINRA is getting feedback from all members of the ETF ecosystem including market-makers, exchanges and ETF issuers. I will certainly be watching anything that could impact the market quality and trading of ETFs and will comment as necessary on this blog. So keep reading!

David Mann’s comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

This information is intended for US residents only.

To comment or post your question on this subject, follow us on Twitter @LibertyShares and on LinkedIn.

____________________________

1. Source: Bloomberg, as of December 31, 2017. For important data provider notices and terms, see www.franklintempletondatasources.com.

2. Ibid.