Software company FactSet, which caters to investment professionals, helps perform ETF due diligence and provides analytics and research on the ETF world as part of its offerings.
Elisabeth Kashner, director of ETF research and ETF analytics at the company, explains why despite innovation with new products and an increasing focus on active management, the best long-term investment strategy remains a passive approach, and why investors will keep flocking to ETFs. (Hint: it’s not because of new products with bells and whistles but because of the low-cost access to broad funds ETFs allow.)
How do you anticipate the ETF market to grow in the next decade?
Since 2011, the average annual growth rate for US-domiciled ETFs has been 14.4%. If that continues, in an atmosphere of flat equity and bond returns, ETFs could cross the $10 trillion
level by 2025. That could be pushed earlier if markets rise overall, and later if a severe correction occurs.
The causes of the ETF takeover are clear and will continue to drive flows to ETFs. The law of averages is a harsh master, but it has shown again and again that the best long-term investment strategy is a passive approach, as active management underperforms more often than not, and with virtually no persistence. Costs are key as well, as fees and operating expenses are a direct drag on returns. Finally, the tax efficiency of ETFs makes them attractive to investors in taxable accounts.
While nobody can predict the overall rate of this change, the direction and magnitude are clear. ETFs will continue to take market share from mutual funds and other pooled investments that fail to deliver cost-effective returns.
What do you think will drive innovation in the market?
ETF innovation will flow to any unexploited corner of the market. Yet, if the trends of 2016 and 2017 hold, innovation will largely go unrewarded, as investors continue to flock to dirt cheap,
simple, broad funds that work well in a buy and hold portfolio.
What’s in store for 2018?
ETFs have several properties that attracted capital following the 2008 market meltdown. In a crisis, investors re-discover the value of transparency, as this allows for informed decision-
making. Competitive pricing will become even more important to any investor who faces disappointment in active managers’ performance in a downturn, as the expected protection
may not materialize.
Finally, intraday liquidity, while perhaps unnecessary under normal market conditions, can be key to investors wishing to take quick action. ETFs are designed to produce exposure to a
specific pattern of returns. When markets collapse, ETF net asset values should collapse according to their exposure. The test comes not in overall returns, but in market function, as
investors will want to see tight trading spreads and fair, timely execution of trades. This is why ETF due diligence matters.