What to Look for in ETFs in 2018

During the year, 275 new products were launched and 136 products were delisted, according to research firm XTF. The announced acquisition by Invesco Ltd.’s Invesco PowerShares of Guggenheim Investments’ ETF business has brought the slow but steady consolidation toward the top of the ETF pyramid. The fourth-largest issuer at $177 billion in assets, when combined, will still trail State Street Corp.’s State Street Global Advisors ($567 billion), Vanguard Group ($851 billion) and BlackRock Inc. ($1.35 trillion). Additionally, three issuers-Global X, Goldman Sachs and Exchange-Traded Concepts-experienced more than 100% asset growth in 2017, according to Toroso Asset Management.

… 5. Active management is redefined. Even supporters of actively managed stock funds argue that active vs. passive/indexing can be boiled down to high cost vs. low cost. (And, yes, there is high-cost passive in some areas of the market.) Now, Vanguard is gearing up to blow a hole in the active/passive distinction by introducing low-cost, actively managed ETFs in the first quarter—index funds with that will home in on areas of the market recently ruled by the smart-beta crowd—namely momentum, value and minimum volatility, among others.

Banks’ equity-research operations are in decline

The equity-research industry was already in trouble. Trading profits at banks have declined since the financial crisis, so they have had to cut costs. Estimates from Frost Consulting show that research budgets at major investment banks have fallen from a peak of $8.2bn in 2008 to $4bn in 2016 (see chart). Headcount seems to be falling, too. Coalition, a research firm, estimates that research jobs at banks have fallen by about 10% since 2012, roughly in line with the decline of front-office jobs as a whole. Moreover, the trend in the industry is towards increased use of “passive” investment funds that simply track a market index. So the demand for research services is in secular decline.

Equity research will not disappear entirely, in part because the industry performs other functions. Surveys have shown that investors are less interested in researchers’ exact forecasts or analysis than in their general industry knowledge. Moreover, much of equity research is actually about “corporate access”, ie, connecting investors with company managers. Fielding phone calls and acting as chaperones may not be as glamorous as publishing market-moving reports. But they are at least labour-intensive activities. Top analysts will still be valued, as will those specialising in niche fields. Independent research firms will benefit. But fund managers will have to do more of their own analysis. And persuading investors to pay for mediocre research will be harder.

Stealth socialism

“Passive” investment vehicles, like those low-fee index funds, now soak up enormous amounts of cash. In America, since 2008, about $600 billion in holdings of actively managed mutual funds (which pick investments strategically) have been sold off, while $1 trillion has flowed into passive funds. So the passive funds now hold gargantuan ownership stakes in large, public firms. That makes for some awkward economics. Research by Jan Fichtner, Eelke Heemskerk and Javier Garcia-Bernardo from the University of Amsterdam tracks the holdings of the “Big Three” asset managers: BlackRock, Vanguard and State Street. Treated as a single entity, they would now be the largest shareholder in just over 40% of listed American firms, which, adjusting for market capitalisation, account for nearly 80% of the market (see chart).