ETF Trends
ETF Trends

As the champagne corks ushered in 2007, investors celebrated more next generation exchange traded funds (ETFs) that promise an exciting variety of targeted new offerings. All grown-up, with everywhere to go, new ETFs continue to hone their appeal for the investing public that craves reduced expenses, diversified risk and targeted investing opportunities exceeding the broad-market benchmarks.

Investors have every reason to be optimistic. The evolution of ETFs sped up significantly in the last year alone—as improving opportunities for jumping into tailor-made sectors that can pack a punch in the way of concentration, while enabling investors to diversify across a wide-array of stocks. The selection is vast and exciting. While new ETFs pop up weekly, their evolution is still just beginning. Here are ten ETF trends we expect to see in 2007.

1) Global ETFs will continue to outperform their domestic counterparts.

Despite the fact that the Dow Jones Industrial Average has staged a 4-year rebound, international investments continue to lure investor cash—and in a huge way. Recent data show that $124 billion of new money has flowed in equity mutual funds this year (including ETFs), with a whopping $110 billion, or 89%, flooding the international arena (AMG Data). This rush to international funds is staggering given the enormous success of corporate America. Last year, across the board, global ETF shares trounced domestic benchmarks, including SPDRs Trust (SPY), Diamonds Trust (DIA) and Nasdaq 100 Trust (QQQQ).

In the new year, we expect international ETF offerings to maintain the foreground. Looking at 2006 numbers for global equities, their growth dwarfs their domestic benchmark counterparts. Equity fund providers will continue to respond to the currently insatiable demand for international investing as international market valuations remain relatively cheap and the burgeoning gross domestic product numbers for specific regions outstrip those of the U.S. Case in point, many ETF providers have launched or filed to launch international ETFs for specific regions, including Asia Pacific, Asia Pacific Emerging, China, Europe, Europe Emerging, other regions, and with varying degrees of market capitalization. The significance of this development is just one indication of the degree of innovation and excitement for ETFs for the coming year.

2) Actively managed ETFs hit the marketplace with a thud.

What was billed as the next generation for ETFs will go over like a lead balloon with investors. Active managers have taken a run at actively managed ETFs—and why not? The enormous success of ETFs has active managers scrambling to entice investors back to active management and big expenses. It won’t happen. Why? The whole point of an ETF is to avoid active management and their expenses. ETF investors have come too far—they have stepped out of the frying pan and they’re not treading back into the fire. They may lure some up-until-now active manager devotees, but there’s no staying power. ETFs have their roots in sectors and sub-sectors of indexes.

As such, investors will look to indexes for the benchmarks, not active management. Actively managed ETFs have no track record—no benchmark. There is no guarantee a mutual fund manager can provide performance results with an ETF.  And, two-thirds of ETF assets come from institutional investors who are looking to find allocations to specific asset classes that also include targeted industry groups and specific global regions. These institutions know what they’re looking for, and where to find it. They don’t need a manager to do their research.

3) The ranks of ETFs will continue to explode.

Tracking indexes enables investors to capture markets, sectors and capitalization parameters. The ETF universe has exploded in just the last couple of years—and for good reason: minimal expenses and innovative offerings target growth through diversified risk. And, they will become even more intriguing as world-class presenters sharpen their competitive instincts to stay at least a step ahead. What’s in the pipeline? Natural resources, bonds, individual emerging market countries, and targeted market capitalization strategies all make for a very exciting year ahead.

Big-name fund providers will continue to pump out more lean, mean asset-building machines for every kind of investor, swelling the ranks of ETFs. Some 345+ targeted and broad-market ETFs collectively boast a current market capitalization of $410 billion in assets. There are predictions that with ongoing new offerings and heftier investments down the road we will see an overall ETF market capitalization upwards of $2 trillion by 2011—just four years from now.

4) Fidelity finally joins the party.

Even as big name ETF providers continue to expand their offerings, the big cheese continued to stand alone. Back in 2003, Fidelity tested the ETF waters with its Nasdaq Composite Tracking Index (ONEQ) fund—the name proved prophetic as it remains their only "ONE." Fidelity’s cash cow continues to be their incredibly lucrative 401(k) plan offerings that carry a much wider profit margin by utilizing their conventional mutual funds compared to the skinny expense ratios of ETFs. Reticent to cannibalize their own market, the giant has remained committed to active management and the hefty fees. However, Fidelity cannot sit out forever and as plan producers feel more pressure to reduce expenses, Fidelity will be forced to enter the ETF game.

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