The State Of The ETF Industry

The State Of The ETF Industry
By Katrina.Tuliao ( [CC BY 2.0], via Wikimedia Commons

Shundrawn A. Thomas serves as executive vice president, head of funds and managed accounts group. He principally oversees the development, management and distribution of Northern Funds, Northern Institutional Funds and FlexShares Exchange Traded Funds as well as related business activities. He also oversees the managed accounts practice which provides investment advisory solutions to existing clients and financial intermediaries. His broad executive responsibilities involve developing long-term strategy, executing operating plans, managing client and vendor relationships and developing and retaining talented professionals.

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Shundrawn received a B.S. degree in accounting from Florida A&M University and an MBA degree from the University of Chicago Booth School of Business.

ETF Industry

Shundrawn’s annual president’s perspective on the ETF industry was just released. This year’s focus is on what he has identified as three key drivers — regulation, institutional investors and efficiency – behind asset growth.

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I spoke with Shundrawn on February 17.

I’ve read your report on the state of the ETF industry, and it documents the explosive growth of ETFs, particularly over the last several years. What were the underlying causes of that growth, and do you expect those causes to persist?

ETFs in recent years have gotten a fair amount of press, but this rapid growth has persisted for over a decade. It’s happened through various market cycles. There are three principal drivers of this growth.

The first is well-chronicled – a secular shift from actively managed strategies to so-called passive strategies, and more specifically, passive index-based strategies. You hear some people questioning whether it’s cyclical, but it’s clearly a secular shift. It’s largely driven by investor preferences for three things: more simplicity, more transparency and more cost efficiency.

The second driver that has pushed the growth in ETFs for more than the last decade is advisor adoption and utilization. In the late 1990s, there was the talk about the shift to the self-directed investor. In many respects, in the last decade we’ve actually seen a reversal on that. It’s not that you don’t have self-directed investors, but the trend we’ve seen is more interest in discretionary investment or advice mandates. Some of that has come through offerings such as target-date and target-risk products that are giving people all-in-one solutions. But, people are moving more towards advisors, and those advisors, for a variety of reasons, have very much embraced and adopted ETFs.

The last driver of the three-legged stool of this growth is the strategic use of ETF by institutions. You’re seeing that institutions have embraced the use of ETFs, and they’re using them in more strategic ways.

You’ve identified four phases of growth in the evolution of the ETF market. Can you discuss those and what you expect the next phase to be?

When I look at four distinctive phases, the fourth is what I’m pointing to as an emerging one, and I’ll get to that because that speaks to the question of what is the next stage and where we’re going.

The first, simply put, was a stage exclusively focused on funds that were tracking well-known, broad-based equity benchmark indices, like the S&P 500 or Russell 1000. Early on, institutions were the primary users of ETFs in tactical applications like hedging, cash “equitization” or transition management. Over time that usage migrated to advisors, certainly in the early 2000s. At the time, most of the strategies were largely those equity benchmark indices; what people call beta or traditional-beta strategies.

The second stage of innovation was distinguished by a move towards other asset classes. You saw interest in commodities and real estate. You saw the first instances of fixed-income strategies between 2004 and 2006. Advisors had a lot to do with that because as they started to use the equity-index ETFs, they were looking to build out more portfolio exposures. They needed access to these classes, and that democratized the use of ETFs.

The third leg of innovation, which we’re still in – and these overlap – is a move towards more sophisticated investment strategies. You see more alternative-weighted index schemes. ETFs are still predominantly index schemes, whether the nomenclature is factor-based or smart-beta. If you look at our FlexShares offering, we would be considered a leader in the alternatively weighted index strategies; it’s 23 of our 25 funds. But that characterizes a lot of the discussion today in terms of where innovation has happened.

The fourth stage is characterized by two things. We have a budding interest in actively managed ETFs. That’s been slow. The first active managed ETFs were launched in 2008. Even today you don’t see a lot of assets there on a relative basis, only about $30 billion. But part of what’s held that back is the need for movement on the regulatory side. There’s a big desire for people to have non-transparent ETFs. As that progresses, you’ll see more interest in certain actively managed strategies; already some spaces like short-duration fixed income have grown. The fourth phase will also be driven by a move towards multi-asset class solutions. People already use ETFs in model portfolios. In fact, I’ve seen different reports that suggest that if you look at a multi-asset class solution of any sort, 51% out of every dollar is being allocated to an ETF. The difference you’ll see is not just people managing multi-asset class solutions using ETFs, but products being launched that will in effect be ETFs of ETFs. They may even be other structures like a collective trust or a mutual fund, but only allocating to ETFs.

By Robert Huebscher, read the full article here.

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