Recently, we took a look back at our exchange traded fund (ETF) predictions for 2008. As 2008 comes to a close, and we look to a new year that will see some big changes, we want to take a look at what we think will be the big trends in the ETF industry.
1. ETFs will grab more than their fair share of assets.
In 2008, investors have left the market in droves. If they stayed in, they often turned to safe haven investments like gold and Treasury bonds. This rush to those investments sent gold prices soaring to record highs in the first half of the year, while driving Treasury yields to record lows in the second half.
But investors also took their money out of the markets, and it’s been waiting on the sidelines in anticipation of an uptrend. When the trends emerge again, we predict that ETFs are going to get more than their fair share and that mutual funds will continue to lose assets. They’re below the $10 trillion mark right now, and we think they’re going to have a hard time making a comeback. Some funds are talking about raising fees; others will be hitting investors with big capital gains distributions. Investors aren’t bound to find that very appealing.
Meanwhile, we think ETF assets are going to double. Investors are tired of getting burned, they’re tired of secrecy, of paying too much for lackluster performance and they’re looking for control over their money. ETFs give them the transparency, control and cost-effectiveness they’re seeking.
2. Hedge funds implode, and ETFs will explode.
As investors get back into the markets, we predict that there will be more launches from providers to give these investors more options. As of the end of November 2008, there were a combined 843 ETFs and ETNs in existence. We think that number is easily going to top 1,000 by the end of the year.
Hedge funds, meanwhile, will implode in the aftermath of the Bernard Madoff scandal. We’ll see hundreds of them close because of lost investor trust. A good portion of those investors are going to turn to ETFs.
3. All eyes will be on 401(k)s.
The market has already witnessed the growth of target-date funds and funds of funds. PowerShares in May launched the first “fund of fund” ETFs. Both iShares and XShares offer a line of target-date ETFs that self-adjust as the retirement date nears.
While there are 401(k)s that feature ETFs, including ING Direct’s Sharebuilder, WisdomTree, Invest n’ Retire and iShares, they’re hardly a staple. ETFs are dying for a share of this market, and target-date funds could help them get in.
At the end of 2007, $3 trillion in assets was held in 401(k)s; $1.7 trillion of that was in mutual funds. The mutual fund market share of the 401(k) market has ballooned from 9% in 1990 to about 57% at the end of 2007, the Investment Company Institute (ICI) says.
4. Mutual funds players will realize ETFs are where it’s at.
Pacific Investment Management Co. (PIMCO) has already filed a prospectus for its first ETF, a 1-3 Year Treasury Index Fund. When they made their announcement, many in the industry wondered if this was the beginning of an all-out acceptance of ETFs by the mutual fund industry. Until recently, the typical thinking seemed to be that ETFs were nothing more than a fad, but it’s rapidly proving to be otherwise. We think it’s the beginning of a beautiful friendship.
5. Commodity ETFs will climb.
Our prediction is that this love affair with low prices is going to be short-lived.
Even Jim Rogers, says not to count out commodities, now or ever. That’s because the credit crisis is creating an inability for farmers to get loans, which means they can’t grow. This will lead to supply shortages, after which high prices ultimately will follow. Food demand is expected to increase, as populations in emerging markets boom and many of those areas adopt a more western diet. Staple commodities, such as corn, soybeans, wheat and sugar could very well continue to see historic levels of demand.
Meanwhile, one positive side effect to the high prices is that people may finally get serious about alternative energy, thanks to skyrocketing costs of oil and Obama’s push for a greener lifestyle. Unfortunately, many feel that this break in oil prices will be short-lived, and demand will resume again at some point, driving the price back up.
6. In recovery, small-caps and value will see action.
Those areas of the markets that were the most beaten-up in the downturn stand to outperform in a recovery. These little companies got badly beaten down in the recession, and they’re going to come back stronger than ever, thanks to their nimbleness. They’re likely not as bogged down by in-house red-tape and bureaucracy, leaving them in a position to react more quickly to market changes. The value side of the market should reveal good bargains when the turnaround begins, too.
7. Investors will wise up about fees.
In fact, investors already are. Many people have seen their portfolios savaged in this market, and we’ve seen people take an interest in their investments like never before. They’re starting to ask questions about where that money is going, they want to know what they own, and they want to know what it’s costing them. These are great things to ask, because it’s going to put the pressure on fund companies and 401(k) providers to not only deliver fair pricing, but to explain that pricing in plain English.
A fee-disclosure rule is expected to go into effect on Jan. 1, which could wind up assisting in the effort to get ETFs into 401(k) plans. The Department of Labor’s rule states that plan fiduciaries have to disclose fees and performance numbers in plain English so that consumers can make an easy comparison of their options.
8. ETF provider competition will heat up.
This year, we saw a number of ETFs liquidate. As the industry grows, we could be seeing more of this. It’s not necessarily a bad thing – after all, not every single fund that is launched can be a success. It isn’t a death knell. The ETF industry is like any other – some products will be successes, others will fall flat. The reasons are numerous: poor product concept, poor timing, poor marketing or just plain bad luck.
9. ETFs will surpass $1 trillion in assets.
This will be thanks to a market recovery, new and interesting launches and an overall investor shunning of mutual funds. As of November 2008, there was $487 billion in both ETFs and ETNs. ETFs have managed to experience net inflows, even in the market downturn. Just imagine how they’ll perform during a boom cycle.
10. Emerging markets bounce back.
Some of these countries had the unfortunate side effect of being dragged down along with the United States, such as China and India, but they’re strong, well-positioned countries in their own right. They’re rich with growing populations, intellectual capital, a growing middle class and growing urban centers. These factors will serve them well when the global economic recovery begins.