The global ETF landscape has seen robust growth in the past years. According to Bloomberg, there were around 6300 products in worldwide marketplace with assets reaching US$2.8 trillion as of the end of 2014. The infliction point was in 2009 when both the number of products and ETF assets increased by approximately 50%. James Martielli, Head of Portfolio Review Asia, at Vanguard attributes that to the financial crisis as it was more challenging for active managers to perform while clients demanded more transparency and lowering of costs.
Speaking at a conference, Martielli analyzes that one of the main reasons for the popularity of ETFs is the capability to create a combination of active and passive investment strategies, in which an indexing core is kept to have beta exposure to broad markets, but also include active satellite factors to look for a higher alpha for performance.
Rule-based active strategy is recommended by Martielli to capture future potentials. Instead of tying to a benchmark, internal rules are set on investments decisions and internal research capability is used to develop and enhance performance and strategies. He believes the process provides a balance between transparency and manager flexibility, and managers can use cash flow and turnover to maintain exposure to a certain criteria and does not have to follow the benchmarks’ re-balance schedules.
He also discussed the importance of global implementation to a successful strategy as it brings more breadth, increased diversity, added liquidity, and capture different cycles in different countries.
Future of ETFs
Looking forward, Martielli expects a trend of lower overall costs and consolidation in numbers of ETFs. The reduction of cost would be especially severe in the passive side as clients now tend to look for lower costs investments.
“But it is also challenging in the active management space,” he adds. “Other than lower costs, clients are also demanding performance. As the market is a zero-sum game, underperformed funds would have to cut back on fees, and this is especially accentuated with the competition with alternative hedge fund strategies.”
He also expects an increase in active management elements in the traditionally passively managed products. “I see an increase of discretionary portfolio management even in the ETF space, especially from banks and independent advisors. Discretionary management is more suitable now also because there are now more regulations in the market,” he says. “And this is actually positive because the interests are aligned between the asset managers and the shareholders.”
A decline of synthetic ETFs, with collateral and swaps as underlying, is already happening in Europe, Martielli expects the trend to spread to Asia but maybe at a slower pace because most contracts have synthetic structures embedded inherently.
Lastly, Martielli anticipates there would be a drop in ETF fund numbers as consolidation would be carried out in the long run, especially in the US. “Funds need to achieve a certain scale to be competitive in the market,” he says. “A lot of new products are too niche to be sustainable.” BM