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News 8 March 2017

Exchange Traded Funds (ETFs): What is This $3 Trillion Market About?

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  • The U.S. ETF industry is growing toward $3 trillion in assets under management, with $288.6 billion in inflows for 2016, compared to the $90.8 billion in outflows mutual funds suffered

 

  • After registering record inflows last year, ETFs began 2018 on a strong note. According to FactSet, U.S.-listed ETFs took in $5.3 billion during the week ending Thursday, Jan. 4, a span that includes one trading session from 2017 and three trading sessions from 2018

 

  • If 2018 inflows are to come anywhere close to last year’s scorching $476.1 billion, investors have to keep plowing money into ETFs at a blistering pace. Total assets under management now stand at 3.4 trillion as of Dec 2017

 

  • Get Ready For The Passive Investment Revolution: Passive Investing is taking the global financial markets by storm and ETFs with their low fees and myriad strategies have made this possible. The world’s biggest money manager Blackrock is moving towards quantitative investment strategies from active stock picking while Warren Buffett has become a champion of passive investing stating that more than $100 billion have been drained into bad investment advice in the past 10 years

 

  • Morn­ingstar’s Leon Ache­son points out that as $340 bil­lion poured out of ac­tive funds last year man­agers have been shown the door. Across firms, lay­offs have ranged from 2% to 10%

 

  • Just how pop­u­lar are ex­change-traded funds? Ac­cord­ing to data com­piled by Credit Su­isse, only one of the 15 most heav­ily-traded se­cu­ri­ties on the stock mar­ket in 2016 was ac­tu­ally a stock. All the rest were ETFs

 

  • To­tal ETF vol­ume in 2016 rose 17% over 2015 and gained 50% over 2014. That com­pared to a 7% rise in trad­ing vol­umes be­tween 2014 and 2016, ac­cord­ing to Credit Su­isse. There are nearly 2,000 ETF listings, an all-time high, Credit Suisse data show

 

  • Passive investment products like exchange-traded funds have hoovered up assets at a fast clip in recent years. US-listed ETFs saw $283 billion in net inflows during 2016, taking aggregate assets under management to $2.5 trillion, according to Citigroup. Exchange-traded funds could gain a further $2 trillion to $3 trillion in assets in the next three to five years, according to a big report on the future of the finance industry from Morgan Stanley and Oliver Wyman

 

  • With ETFs set to see their share in the US market increase from 15% to 40-60% over the next ten years, according to Credit Suisse, fee compression in the mutual fund industry will likely continue. Morgan Stanley estimates that fees charged by active managers could shrink by more than a third in 2017

 

  • According to Morgan Stanley and Oliver Wyman, mutual funds are now using ETFs, the very funds that have contributed to price compression, to cut their own costs. By investing in ETFs, mutual funds are able to free up time to focus on “more complex alternative investments,” the report said. Here’s Morgan Stanley and Oliver Wyman’s explanation:

 

  • “Asset allocators such as Outsourced Chief Investment Officers (OCIO) and Wealth Managers will account for a large proportion of this incremental demand as they increasingly use ETFs at near zero cost to source beta exposure, allowing them to focus their resources on high conviction managers or more complex alternative investments. However, looking beyond 2019, the emerging use of passive vehicles as an integral part of an active fund management strategy will be arguably the more significant dynamic. Currently, Mutual Funds have ~$0.5TN invested in ETFs, much of which is used for liquidity management. We estimate using ETFs rather than the traditional approach of holding individual stocks offers a cost advantage of 5-8 bps in large and mid-cap equities. As Asset Managers search for ways to deliver performance at lower costs, this may mean that mutual funds find themselves among the largest investors in ETFs.”

 

  • What Is An Exchange Traded Fund (ETF)? An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors. Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated once at the end of every day like a mutual fund does

 

  • What Is A Smart Beta ETF? A smart Beta ETF is a type of exchange-traded fund that uses alternative index construction rules instead of the typical cap-weighted index strategy, in a transparent way. It takes into account factors such as size, value and volatility. It utilizes both passive and active methods of investing … passive because it follows an index, but active because it considers alternative factors. Smart Beta ETFs are ideal for investors hoping to maximize their income and returns and minimize risk. According to Blackrock, this relatively new class of ETFs is expected to grow at a 20% annual pace from $282 billion to $1 trillion in assets under management by 2020. These growth rates would make smart beta ETFs a part of most investors’ portfolios, alongside passively and actively managed funds

 

  • The growth is expected to pick up pass, with a survey of ETF professionals by PricewaterhouseCoopers showing that predicted ETF assets under management would expand to $5.9 trillion by 2021, or a 23% cumulative annual growth rate, as investors enjoy the low cost of the ETF structure

 

  • There are now U.S.-listed 1,978 exchange traded products, which include both ETFs and exchange traded notes, with $2.6 trillion in assets under management and an average expense ratio of 0.57%, according to XTF data. The cheapest ETF options include broad U.S. stock strategies with a dirt cheap 0.03% expense ratio

 

  • As the ETF industry continues to grow, we will likely witness the continued fall in traditional actively managed open-end mutual funds, especially those that have consistently underperformed and charged high fees – the S&P has found that about 80% of active managers have failed to outperform for years

 

  • Among the hot new areas in ETFs, smart beta or alternative factor-based index ETFs are all the rage. These smart beta themes combine actively managed styles in a passive rules-based index structure to help investors potentially enhance returns and diminish risks

 

  • With the continued growth in the ETF space, more money managers and even mutual fund firms are crafting ETFs. As many plain vanilla index-based themes are already well populated, ETF sponsors have increasingly turned to niche or focused strategies to slice the markets into smaller segments

 

  • Assets under management (AUM) in European-domiciled ETFs have doubled over the past five years to approximately EUR 550 billion at the end of December 2016 and are now at par with the longer-established market for traditional index funds

 

  • European retail investors have yet to fully embrace ETFs, but distribution channels are slowly opening. Incoming regulation like MiFID II should help. In the meantime, the growing popularity of robo-advisors has advanced the case for the use of ETFs by cost-wary retail investors

 

  • The European ETF market remains top heavy, with the three largest providers controlling about two thirds of total assets and BlackRock retaining its position as the dominant player with its iShares range

 

  • The market share of fixed-income ETFs has increased in each of the past five years and now stands at over 24%, up from 16% in 2011. ETFs are proving a handy tool to gain exposure to fixed income in an environment where the traditional channels to access the asset class have been severely constrained by post-crisis bank regulation

 

  • The shift from synthetic to physical replication continues, with assets in physically replicated exchange-traded products now representing 77% of the market, up from 66% three years ago.

 

  • Providers have launched increasingly complex products, such as strategic or ‘smart’ beta ETFs, with AUM in strategic-beta ETFs quadrupling in four years, landing at EUR 43 billion as at the end of 2016

 

  • The European ETF market has become a sweet spot for active fund managers looking to diversify their offerings, with strategic-beta offerings the favoured avenue

 

  • Advantages of ETFs: By owning an ETF, investors get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share (there are no minimum deposit requirements). Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you’d pay on any regular order. There exists potential for favorable taxation on cash flows generated by the ETF, since capital gains from sales inside the fund are not passed through to shareholders as they commonly are with mutual funds

 

  • Widely Traded ETFs:

 

  • One of the most widely known and traded ETFs tracks the S&P 500 Index, and is called the Spider (SPDR), and trades under the ticker SPY.
  • The IWM trackes the Russell 2000 Index.
  • The QQQ tracks the Nasdaq 100, and the DIA tracks the Dow Jones Industrial Average

 

  • Sector ETFs exist which track individual industries such as oil companies (OIH), energy companies (XLE), financial companies (XLF), REITs (IYR), the biotech sector (BBH), and so on

 

  • Commodity ETFs exist to track commodity prices including crude oil (USO), gold (GLD), silver (SLV), and natural gas (UNG) among others

 

  • ETFs that track foreign stock market indices exist for most developed and many emerging markets, as well as other ETFs which track currency movements worldwide

 

  • The top five Country ETFs of 2016: 1) iShares MSCI Indonesia ETF (EIDO) The iShares MSCI Indonesia ETF (EIDO) 2) Global X MSCI Colombia ETF (GXG) 3) iShares MSCI Thailand Capped ETF (THD) 4) iShares MSCI All Peru Capped ETF (EPU) 5) iShares MSCI Brazil Capped ETF (EWZ)

 

  • ETFs Versus Mutial Funds:

 

  • ETFs have found their way into countless portfolios in recent years as investors of all sizes and experience levels have grown to embrace the instant diversification, unparalleled transparency, and intraday liquidity that these financial instruments have to offer

 

  • Another reason, and perhaps the more obvious one, that has prompted many to jump ship from mutual funds and into exchange-traded products is the glaring difference in costs; it’s no secret that ETFs boast tremendous cost-efficiency benefits over their mutual fund counterparts

 

  • A lot of noise has been made about the cost-advantages that ETFs boast, and for good reason: there’s no more surefire way to improve your returns over the long-haul than by reducing the amount you pay in management fees

 

  • Why Expense Ratios Matter: Most investors are keen enough to recognize that a small difference in expense ratios can lead to a big difference in returns over a long enough time horizon. But just how powerful is the ETF cost-advantage? Consider the following hypothetical example: let’s assume you invest $100,000 over the course of 30 years and generate a 6% return annually. On one hand, you could invest in a mutual fund that charges 1.5%, or you could opt for an ETF that offers comparable exposure but costs only 0.35%

 

  • Surviving A ‘Flat” Market: The higher fees you are likely to pay for a mutual fund can take their toll even when the market isn’t necessarily going against you. Consider the following hypothetical example: let’s assume you invest $100,000 in a mutual fund charging 1.5% in fees annually. Now let’s suppose that over the next 30 years the market turns in a flat performance

 

  • Investor Profits Versus Fees Paid: Some mutual funds are notorious for charging expenses that go beyond the stated management fee. One of these fees is a front-end load, which is an expense you incur at the time of purchasing your mutual fund shares. For example, if a fund charges a 5% front-end load (some can charge even more) and you invest $100,000, your initial investment will come out to only $95,000 after you pay this fee. Now let’s suppose you invest $100,000 in such a fund; the chart below compares your profit and the fees you end up paying over the course of five years, assuming the fund costs 1.5%, charges a 5% front-end load, and returns 5% annually

 

  • Load Fees: Load fees can be a burden as the above example clearly demonstrates, but the list of quirky expenses you’re bound to encounter when shopping for a mutual fund doesn’t end there. If you’re not careful enough in reading the fine print, you could be left with a mutual fund that boasts a 12b-1 fee. So what exactly is that? In the simplest terms, the 12b-1 fee is the annual marketing expense, included in the management fee, that many mutual fund companies incur, and ultimately pass off to investors

 

  • Comparing Apples To Apples: On the one hand, you have VEIEX, a mutual fund that charges 0.33% and doesn’t have any load fees; one potential drawback however is the fact that this mutual fund requires a minimum investment of $3,000. On the other hand, as suggested on VEIEX’s profile page, you could opt for the ETF version of this mutual fund; the Emerging Markets ETF (VWO A), which charges 0.15% in expense fees and doesn’t have any load fees or a minimum investment requirement. Now let’s suppose you invest $100,000 in each of these two vehicles over the course of 30 years, assuming 6% annual returns. The difference between the two investments after 30 years is by no means jaw-dropping; the mutual fund leaves you with $523,060 while the ETF alternative leaves you with a slightly heftier $550,460. While this difference may not be staggering, it does amount to $27,400 after 30 years, which are additional funds that you could be putting to work if you simply opt for the lower-cost ETF alternative

 

  • How Can We Profit From This New MegaTrend? AlphaPlus: The World’s First Capital Protected ETF Fund: US-listed ETFs saw $283 billion in net inflows during 2016 and Morgan Stanley sees ETFs gain a further $2 trillion to $3 trillion in assets in the next three to five years. AlphaPlus is the first of its kind, capital protected, ETF Fund that capitalizes on long/short sector, country and index based strategies in the $2.7 trillion US ETF market. Read Full Strategy (FREE ACCESS): bit.ly/AlphaPlusCapProtect