In its first issue of “In The Know,” J.P. Morgan Asset Management highlighted a bevy of trends apparent in the current ETF landscape, such as the flow of capital, as well as opportunities abound in U.S. equities, international equities and fixed income. As the capital markets move forward and strategies adjust in this extended bull market, financial advisors and investors alike must be stay abreast of these changes to identify profitable opportunities.
With the S&P 500 recording the longest ever bull market and the Nasdaq Composite breaking past the 8,000-point level, many market pundits are already predicting that the capital markets are ready to shed its late market cycle skin. If that’s certainly the case, then investors can begin their profitability-seeking research by simply following the money.
ETF Shopping Spree
The first quarter of 2018 saw outflows in ETFs–a first in the previous two years, but that proved to be temporary as investors returned with cash-in-hand during the second quarter, resulting in an ETF shopping spree. ETF investors weren’t short of choices as there were roughly 2,000 funds to choose from–a total of $3.5 trillion in assets.
This exponential growth in ETFs the past decade is showing no signs of scaling down.
“With net flows of $123 billion year-to-date, growth is expected to continue as additional ETFs enter the marketplace,” the report said. “The number of ETFs has increased 3.2% in 2018 with 170 new funds launched and 102 delisted since the start of the year. A majority of the AUM sits in market-cap weighted strategies, $2.7 trillion in fact, compared to strategic beta and active strategies, which represent $746B and $58B in AUM, respectively.”
Related: In the Know – Stay up to date on ETF This Quarter
Late Cycle Opportunities in U.S. Equities
A lot of investors are wondering whether they are late to the party now that the market has turned the corner and is maintaining speed on “Late Cycle Street,” but where exactly is it headed? According to the JP Morgan report, rather than relying on traditional market-weighted capitalization strategies, investors are beginning to flock to strategic beta or factor-based strategies.
With a rise in volatility and an economic landscape of rising rates, investors are keen to use these strategies to help diversify their portfolios.
“Traditional market cap-weighted indexes may be less diversified than they appear,” the report stated. “A market-cap index, by the nature of its weighting mechanism, is prone to concentrations of risk across regions, sectors and stocks. While this may result in strong short-term performance, it increases volatility and reduces long-term performance, which significantly impacts investor behavior.”
For the most part, JP Morgan sees three ways that investors are using smart beta/multi-factor ETFs with respect to their portfolios: core allocation, core blend and active core blend.
Growth Opportunities in International Equities
While U.S. equities continue to thrive, opportunities abroad cannot be ignored. Despite faltering on year-to-date basis in 2018, emerging market valuations could present opportunities for savvy investors on a going-forward basis.
While investors can still capitalize on the growth of U.S. equities in their portfolios, emerging markets is able to capture a diversification aspect necessary at the current, cheaper valuations. Should U.S. equities languish, investors with capital allocated into emerging markets are potentially exposed to international opportunities where the markets are beginning to gain strength following weakness.
“While opportunities still exist in U.S. equities, investors should ensure they have enough exposure to international equities,” the report noted. “With the U.S. economy in the later innings of its expansion, international exposure is increasingly important. Over the next decade, a meaningful allocation to international equities will be crucial to improve overall equity returns.”
While the current bull market has put U.S. equities in the forefront, other asset classes like fixed-income can’t be ignored. For the fixed-income investor, JPMorgan Ultra-Short Income ETF (BATS: JPST) can serve as a flexible tool during times when rates are decreasing or rising. Right now, the Federal Reserve is primed to incorporate two more rate hikes through the rest of 2018, but that shouldn’t deter fixed-income investors.
The floating rate component of bonds in JPST’s debt portfolio would effectively hedge against interest rate risk and capitalize on any short-term rate adjustments the Fed decides to make through the rest of 2018 and beyond.
“With the difficult combination of navigating rising interest rates and a low-yield environment, fixed income investing will require creativity and flexibility going forward,” the report mentioned. “Identifying pockets of opportunity will be more important than ever.”
To help construct a fixed-income portfolio built for today’s market environs, JP Morgan suggests maintaining a broad allocation to core bonds to nullify volatility in stocks, augmenting with core complements to reduce fixed income volatility and adding extended sectors to increase income and return potential.
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