Expert Insights: Outlook For The Global ETF Market In 2018

The extraordinary success that ETFs saw in 2017 will be hard to improve upon, but from 50,000 feet, as one takes the pulse of the passive investments landscape, it is quite likely that ETFs will continue to dominate the headlines for some time to come. During 2017, over US$600 billion of net new assets poured into equity and fixed income ETFs, albeit with the lion’s share of that business happening in the US. Likewise, Asia and Europe also fared relatively well with net new ETF assets of US$45 billion and US$95 billion respectively.

As the ETF industry celebrates its 25^th year, in the US the long tail of the full spectrum of new funds that continually seem to get launched must surely be under pressure once one realises that the top three providers of ETFs – BlackRock, Vanguard and State Street – account for a combined market share of more than 75%.

Yet somewhat surprisingly, it feels like the strong growth phase for ETFs in Europe and in Asia has barely started. After what must count as one of the longest periods of regulatory anticipation, MIFID II is finally up and running in Europe, and early indications suggest this new legislation, designed to favor transparency and protect end investors, is likely to increase the take up of ETFs.

These new regulations are forcing brokers to report trading volumes, and as a direct consequence published volumes have increased as has the apparent level of liquidity. Gone are the days when one simply didn’t know how deep the ETF market was in Europe. While this boost to confidence has been well received it is the regulation regarding the visibility of management fees and trading costs incurred while managing a fund that is most likely to tip the balance in favor of passive investing.

Of course, it is too early to tell if this will change advisors’ fund selection habits, but initial indications have seen the impact on active managers as they are forced to publish the costs incurred while managing their portfolios, and it isn’t pretty. Let’s not forget the arrival of what was once considered a pipedream of a Pan-European “Single Tape” for ETF Volumes in Europe is a game changer and could seriously move the goalposts for the European fund management industry.

In Asia, the picture surrounding ETF growth is somewhat different. There are instances of funds being de-listed in Hong Kong, partly due to the delay of the ETF Connect program with China. Should one be surprised, maybe, but almost certainly this will be a short-lived phase as the economics of the fee compression that is sweeping across the industry knows no boundaries. As more and more firms in mainland China and beyond look to step up to the opportunity that ETFs afford them to scale up their business, then one can only imagine there will be no turning back.

With many equity markets having delivered a good 18 months of solid returns (albeit with a correction at the end of it) it is only natural to ask if it will be a prolonged market correction that stalls the ETF juggernaut as the task of being an investment manager becomes one that demands much more skill?  One has sympathy for those active managers that claim after many years of loose monetary policy, market valuations have been distorted by somewhat favoring passive investments. That said, there is every reason to believe the coordinated strength of the global economy which goes from strength to strength could itself take over from where Quantitative Easing left off.

The clamor to reap the benefits that the likes of Smart Beta ETFs promise the end investor will be hard to ignore. The realisation that most market professionals bought into the concept of “Factor Investing” quite some time ago suggests this will be the most exciting driving force that re-shapes the industry from one end of Asia to the other.

Hand in hand with the increasing interest in all things Algo is the increasing role that B2B2C and D2C platforms play in the brave new world of low cost investing. As the size of the Smart Beta ETF sector now exceeds US$500 billion, combined with the fact that ETFs are now outstripping hedge funds for market share, don’t be surprised if more and more asset managers leverage smart products for the benefits of all investors. We know for sure that as market volatility steadily increases, albeit from an unusually low base, this will bring the investment and fund selection process of both active and passive managers brutally into the spotlight. However, much has changed since the Global Financial Crisis of 2008. The onset of robo-advisors suggests that maybe the era of “Rules Based Investing” is the best way to describe where we are today.

As more and more managers get comfortable with the versatility that ETFs bring to the table, as the market turns, then the old maxim that necessity is the mother of invention will see an increasing number of managers use ETFs as the vehicle by which to employ their tactical investment decisions.

One of the lesser known truths of the ETF industry is the realisation that active managers remain the biggest users of ETFs. As market conditions change with the macro-economy one can be fairly confident there’s an ETF already available that offers the exposure one needs.