Exchange traded funds provide a low-cost, efficient and liquid ways to capture the broader markets, but there is a shift in the way the industry is engineering new fund products.
The ETF industry has quickly expanded. There were only 79 ETFs to choose from back in 2000, reports Suzanne McGee for The Guardian. In comparison, there are now 1,503 U.S.-listed ETFs; however, the industry is beginning to show signs of slowing down as it matures.
“The ETF market is pretty saturated right now in terms of ‘plain vanilla’ funds,” Samuel Lee, Morningstar ETF analyst, said in the article. “You can get almost free exposure to, say, U.S. stocks. Even emerging markets, once an exotic and expensive-to-access asset class, can be had for a low 0.20% annual fee.”
Consequently, Lee expects the next stage of ETF growth to come out of alternative strategies beyond the plain-vanilla, beta index ETFs we have become accustomed to.
“ETFs have been a field where providers have been able to innovate historically,” Lee added. “There have been lots of examples of providers offer products that are very niche-like, for instance, but also offering exposure to very creative parts of the market, like stocks deemed to be of ‘high quality,’ or offering above-average momentum.”
Specifically, Lee points to the growing number of “quasi-actively managed strategies, or ‘factor’ strategies” that utilize enhanced, smart-beta indexing methodologies.
Additionally, Lee argues that the relatively small active ETF space could become more popular if fees decline, more rock star managers get into the space and more investors familiarize themselves with the investment.
“That’ll take a while, I think,” Lee added. “ETFs for the foreseeable future will be passive.”
When it comes to investing in ETFs, Lee suggests investors should follow three rules:
- “Stick with the most boring, highly liquid, low-cost ETFs you can find.” Most investment portfolios should include large and broad “core” holdings.
- “If it’s leveraged, can be classified as an ‘alternative,’ or promises something brand new, ignore it.” Newer fund products can be speculative or tactical in nature as they track smaller markets.
- “Stick with big sponsors. They’re far less likely to leave in in the lurch.” Large fund sponsors are less likely to shutter an ETF as it might hurt their brand.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.