This year promises to be a fiercely competitive one for the exchange-traded-fund market.
Blame it on the Securities and Exchange Commission. In December, the SEC put into effect a rule that makes it easier to issue new ETFs, especially those that disclose their underlying investments daily. Impacts from the new rule will include less red tape for launching new products and more flexibility in how ETFs build the baskets of securities they use to manage assets flowing into and out of their products.
The SEC last year also gave a green light to a new type of actively managed ETF that isn’t required to fully disclose its portfolio daily. Together, these developments mean that ETF investors could see a host of new issuers, including new actively managed ETFs from established investment firms that have been slow to enter the market. If analysis paralysis hasn’t already set in for anyone trying to pick from the nearly 2,200 ETFs now on the market, according to FactSet, expect even more choices in 2020.
In terms of fund flows, 2019 was more business as usual. Net flows into ETFs were about the same as the year before, $326 billion, split almost evenly between equity and fixed income. Fixed-income ETFs saw an increase of about 18% in net flows, reaching total year-end assets of $849 billion, according to FactSet. Equity ETFs, working from a much larger base, added about 4%, reaching $3.4 trillion.
But while net flows were modest, returns on equity-based ETFs for the year were not: The average unleveraged fund was up 24% on capital appreciation alone, according to XTF.
Here are five trends in ETF markets to watch in 2020.
The ETF Rule is in effect. After years of fits and starts, the Securities and Exchange Commission finalized an “ETF Rule” that (as of Dec. 23) levels the playing field for asset managers and investment advisers looking to launch an ETF product. The rule permits fully transparent ETFs, which disclose their portfolios daily regardless of investment strategy, to launch faster, without having to seek exemptive relief from certain stipulations in the Investment Company Act of 1940, which governs ETFs and mutual funds. It also grants to all issuers the ability to customize the basket of securities accepted for creation or redemption of an ETF’s shares. Many ETF issuers, particularly those who could use custom baskets before the new rule, argue that custom baskets allow them to be more flexible in how they move certain assets in and out of the ETF efficiently.
A new kind of actively managed ETF. A set of potential products explicitly outside the scope of the ETF Rule are also gearing up for an interesting year. After almost a decade of maneuvering, five ETF issuers were given the green light on actively managed ETFs that don’t necessarily disclose their full portfolios daily. Precidian Investments, Fidelity Investments, T. Rowe Price (TROW), Natixis (NTXFY) and Blue Tractor Group all received approval from the SEC for their proposed structures that provide some cover for investment managers using a proprietary strategy, while also delivering enough intraday information to generate creation/redemption activity and keep prices in line with net asset value. (Natixis is licensing a structure developed by Intercontinental Exchange Inc.’s (ICE) NYSE Group, while several fund issuers have disclosed licensing agreements with Precidian.)
Details about pricing and timing are slowly coming out. So far, Fidelity, Precidian and American Century, a Precidian licensee, are seeking exchange approval for their initial products. T. Rowe Price revealed management fees for four ETFs under their new structure that are in line with institutional share classes for some of its largest U.S. funds, such as its $70 billion Blue Chip Growth Fund (TBCIX) which requires an initial investment of $1 million.
Matthew Bartolini, head of SPDR Americas research for State Street Global Advisors, says that the various structures will need to prove themselves in volatile markets. “How will market makers react when spreads blow out [between price and NAV]?” he asks. Institutional trading firms often watch ETF trading for any discrepancies between ETF share prices and the underlying values of the individual shares that make up the ETF basket. When there are differences, these traders buy or sell the respective investments, typically making a profit on the arbitrage. For the yet-to-launch actively managed ETFs, however, many are expected to have proxy or cash-only baskets making real-time calculations of an arbitrage harder for traders.
The ABCs of ESG. Last year’s buzziest acronym, ESG—representing funds that invest along some notion of environmental, social and governance screening or scoring of their investments—will be under the microscope this year as the SEC is reportedly looking into investing methodologies and disclosures around the marketing of such funds.
“There is currently no standard on how to measure these products,” says Sal Bruno, chief investment officer for IndexIQ, the ETF division of New York Life Investments.
Still, within ESG-related ETFs, investors couldn’t get enough, plowing $8.3 billion, or 42% of year-end category assets of $20.15 billion, primarily into equity ETFs, according to XTF. With many of these funds just gaining assets and attention, performance and index tracking will be the ultimate arbiter.
Free fallout. Retail trading commissions have hit the floor (unless they go negative). No matter who started it, the end of trading commissions for ETFs (and stocks) at many major brokerage firms removes additional cost from owning and rebalancing a portfolio of ETFs, relative to mutual funds.
State Street’s Mr. Bartolini argues that this development will drive more investors to the largest and most liquid ETFs, and away from products that had promotional deals on their own and third-party platforms. State Street, BlackRock (BLK) and Charles Schwab (SCHW) have all demonstrated that a commission-free ETF is an effective way to build an asset base in broad-based index-tracking ETFs. In October 2017, State Street announced a deal with TD Ameritrade (AMTD) to offer low-cost, core-portfolio solutions commission-free to its customers. That strategy helped drive billions of dollars into State Street offerings very much in line with strategies already offered by BlackRock, Vanguard and Schwab.
The elimination of commissions resets the field, and the planned merger of Schwab and Ameritrade will make brokerage-based product promotions even more challenging.
Increasingly “active.” The ETF Rule and the inception of new actively managed products couldn’t come soon enough for an industry that seemingly never saw a product it couldn’t launch. In 2019, net new ETF issuance came in at 121, compared with 159 in 2018, according to FactSet. And 2020 starts off deep in the hole, with Invesco (IVZ) already announcing plans to close 42 products as the fourth-largest ETF issuer digests recent product additions from OppenheimerFunds and Guggenheim Investments.
Market leaders BlackRock, meanwhile, with $1.7 trillion in ETF assets under management and $115 billion in 2019 net flows, and fast-rising Vanguard, with $1.1 trillion and $102 billion in flows, have reached a size and scale that are hard to challenge. The heat will be on for smaller, innovative issuers to protect their brands and intellectual property or risk being subsumed by the large issuers.
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