Inflows into exchange-traded fund (ETF)1 investment structures surpassed $280 billion in 2016, exceeding the previous annual record of $244 billion set in 2014.2 We believe activity in this space is likely to continue in the year ahead. Here are five potential ETF trends for investment professionals and their clients to keep in mind as they enter the new year.
Trend #1 – Active transparent ETFs may gain increased attention. We have seen a gradual shift of active strategies3 from being exclusively offered as mutual funds to increasingly being offered as transparent ETFs and 2017 could show a continuation of this. A key driver for this trend may be the potential tax efficiency of ETFs,4 in addition to their trading flexibility. Many ETFs disclose their full portfolio to the public online, and update this disclosure daily. Moreover, ETFs trade in a manner similar to individual securities – they can be bought and sold throughout the day.
Trend #2 – International equity ETFs may return to favor with investors. The last quarter of 2016 saw strong cash flows into U.S. equity ETFs. We believe this is related to the election of Donald Trump as U.S. President and the enthusiasm around his tax and infrastructure ideas. 2017 could usher in a rotation into non-U.S. equities. Investors may diversify away some U.S. equity exposure that has likely been increased through trading activities or due to market appreciation.
Trend #3 – Fixed-income ETFs could gain the attention of investors seeking greater yield on certain sleeves of their portfolio. Over the last 5-7 years, low interest rates have forced many investors to look for yield in unconventional places. The recent increases in U.S. interest rates may allow investors to carefully return to conventional fixed-income products. It is possible that this interest will focus on the shorter end of the yield curve,5 and perhaps intermediate, as interest rates are expected to continue to rise. Additionally, we believe there will be continued interest in fixed-income products that have frequent interest rate resets, such as adjustable rate products.
Trend #4 – Volatility-managed ETFs could be of interest to investors in 2017, as some analysts are anticipating more volatile equity markets for at least the next year. This could be due in part to a strong second half of 2016 for equity markets and the suggestion by some market analysts that the U.S. market is moving to the back end of the current business cycle. Volatility-managed ETFs are varied. Most offer investors exposure to a desired asset class, but seek to modify the level of risk an investor must absorb during the ownership of the product.
Trend #5 – Active non-transparent ETFs have been talked about for the last few years, and a small number of regulatory filings have occurred seeking to launch these products. Innovations in this area could continue in 2017. Active non-transparent ETFs have the potential to address a critical challenge: Many active portfolio managers are uncomfortable publicly releasing their holdings (stocks, bonds, etc.) on a daily basis, which is required by the regulator for active ETFs. Their fears are that some investors will copy their trades or trade ahead of them. As a result, product innovators are seeking ways to restrict holdings disclosure to the time periods typically used by mutual funds, such as every 30 days or quarterly, with a 15-day lag in the release. If this innovation can gain the proper regulatory approval and be constructed in an ETF structure, it could bring a lot more interest and assets into ETF vehicles.
More information on the evolution of exchange-traded funds is available here. Stay up to date with current market trends and investor sentiments on our Latest Insights page.
1 An exchange-traded fund, or ETF, is a marketable security that tracks an index, commodity, bonds, or a basket of assets like an index fund. ETFs trade like common stock on a stock exchange and experience price fluctuations throughout the day as they are bought and sold.
2 Roy, Sumit. “2016 ETF Inflows Set New Record Above $280B.” etf.com. 9 Jan. 2017. Web. http://www.etf.com/sections/weekly-etf-flows/weekly-etf-flows-2016-12-29-2016-12-23
3 Active management (also called active investing) refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index. Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio.
4 The potential tax efficiency of ETFs is a result of the in-kind redemption process of ETF shares. When an Authorized Participant (AP) wants to redeem ETF shares, the fund manager does not sell the underlying securities to raise cash (a taxable event) but instead transfers the underlying securities in kind to the AP (not a taxable event). This process can result in less capital gains for the ETF and offers the potential for the fund manager to control their tax lot levels, transferring out the lowest tax lot securities first.
5 A curve that shows the relationship among bond yields across the maturity spectrum.
Unlike typical exchange-traded funds, there are no indexes that an active ETF attempts to track or replicate. Thus, the ability of an active ETF to achieve its objectives will depend on the effectiveness of the portfolio manager. Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns.
Investing involves risk, including the risk of loss. Investment risk exists with equity, fixed-income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
Natixis Global Asset Management does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions. This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
Understanding current market conditions and what might be expected in the near term.
Understanding potential market trends in early 2017 requires a look at the market’s recent optimism.
During periods of market optimism, remaining mindful of risk is still important.