Vice President, ETF Services
Brown Brothers Harriman
As a global service provider with over $500 billion in ETF assets under custody, Brown Brothers Harriman (BBH) has a unique perspective on the industry given its centralized role within the ETF ecosystem.
For the fifth year in a row, BBH has co-sponsored with ETF.com a survey of professional investors, including financial advisors, RIAs and institutional investors. A summary of the survey results is published in this issue of ETF Report. Here, Ryan Sullivan, vice president of ETF Services for BBH, discusses some of the key findings.
What were your key takeaways from looking at the data?
The biggest takeaway for me was that 65% of respondents said they view smart beta as a hybrid strategy, and essentially somewhere in the middle of the active/passive continuum. They seem to be thinking of smart beta as a Swiss army knife: something that’s versatile, offers a lot of optionality, and can play multiple roles within a portfolio strategy.
With that in mind, while there was an increase of usage in smart beta as a whole, about a third of respondents still said they have a limited understanding of smart beta as a strategy. That shows there’s still opportunity for ETF managers to reassess their marketing campaigns and investor education initiatives, and look to help this portion of advisors to better understand the products and how they might be deployed in a portfolio.
Were there any year-to-year changes in the results that you found interesting or significant?
One that jumps out at me was active ETF usage—26% of the respondents highlighted actively managed ETFs as an area where they want to see more products. Emerging markets equity was a particular focus, as 54% of respondents wanted to see more actively managed strategies in this space. Developed-markets international equity was another big request, with 44% of respondents wanting to see more active product there.
On the flip side, we saw a drop in advisors and investors who wanted actively managed fixed-income funds. While last year, 42% were looking for fixed-income active strategies, only 6% responded that way this year. That is a substantial drop, which might tell us that the near-term outlook for fixed-income active strategies will continue to weaken as advisors tilt portfolios away from fixed-income exposure, and look to capitalize on the returns available in global equity markets.
So fixed income is out of favor in a way?
We’ve been tracking bond liquidity in the last few surveys. The results show that there is more focus on the underlying liquidity in the bond market this year than in past years. This year, 30% of respondents said they were very concerned about bond liquidity versus 12% for last year. This definitely seems to be front-of-mind for many investors.
A concern around underlying liquidity could lead some investors to trim positions in fixed-income ETFs. This presents an opportunity for ETF managers to educate advisors and their ETF investors about liquidity—not just of the ETF shares, but in the underlying bond market, and how the nuances and specifics of the ETF wrapper can help maintain some of that liquidity and ease trading in these markets.
The wording changed a bit this year, but expense ratios seem to be very important to investors when it comes to selecting ETFs. What do you think is happening there?
This was another result that really jumped out at us. The importance placed on ETF expense ratios consistently ranked high this year. Overall, 64% of respondents said expense ratio was the most important factor in ETF selection, above index methodology and historic performance. Even when specifically focusing on active ETFs, 67% of investors said expenses were very important, surpassing performance and manager expertise. Investors are selecting ETFs primarily with their wallet. It will be interesting to see if the fee competition across ETF managers further expands into smart-beta and active offerings in 2018.
Do you think the Department of Labor fiduciary rule has something to do with the boost in importance of the expense ratio?
There has been no shortage of media coverage lately, but the trend toward low-cost investing has been underway for some time—well before the DOL rule was announced. Even now, there’s significant uncertainty around the implementation of the rule, its timeline and how it will be enforced, but the trend toward low-cost funds will continue regardless. It’s been the new normal in the advisor market for a number of years. We’re also seeing it take hold in other channels, especially with institutional investors.
A lot of ESG funds launched this year and there were quite a few last year. More than half of the respondents said there was at least some importance, if not significant importance, when choosing an ETF. Is that awareness of ESG criteria and ESG strategies growing?
Growth in ESG awareness has absolutely picked up in this research, where we saw a flip relative to last year. In 2016, the majority of U.S. investors were saying ESG wasn’t important, which is different than what we saw in Europe, where ESG has been consistently highly regarded. The 2017 results might be evidence that the U.S. is coming up the curve with respect to ESG adoption and its inclusion in portfolio strategies.
It’s good to see advisors and investors are coming around on the benefits of ESG strategies. There’s been no shortage of product development in this space over the last 18 months or so, and ETF managers certainly have been leading that curve. This indicates U.S. investors are slowly shrugging off the perception that ESG could limit the upside of a portfolio. While that was a concern with some older and more exclusionary strategies, many of the newer and more innovative strategies are far more inclusive. They’re able to zero in on specific aspects of the ESG market that may present alpha opportunities, or even position a portfolio for downside protection.
ESG is really a subset of the smart-beta market, where a strategy is trying to sever the tie between index design and market capitalization. The growth of this product segment is an example of just how versatile these products can be.
What areas do you see as important for issuers or even practitioners to focus their educational efforts on?
I see the need to focus on education around bond liquidity and the broader state of the bond market. This is an opportunity for managers to continue highlighting the liquidity levers that exist with fixed-income ETFs, whether it be at the ETF share level or the liquidity of the underlying bond market, and how that factors into the creation of their ETF basket and the tradability of the product.
As mentioned, smart beta is also ripe for education. Getting back to my Swiss army knife analogy, with regard to investor deployment of smart beta within their portfolios, we saw a tremendous amount of variability when we asked how respondents use smart beta within their portfolios. Most respondents answered that they occasionally use smart beta to generate alpha, as a risk management tool, to lower volatility or to enhance diversification.
With the broad versatility of smart beta, it’s incumbent on managers to continue the dialogue with their investors and determine its primary uses for their segments. Does it differ by advisor type or by channel? ETF issuers need to match up the usage of the funds with their product narrative and how they’re positioning their smart-beta lineups in the market. Given the versatility of the product, the practical use of a smart-beta strategy may differ from the way an ETF manager intended.
A good example of this is shown in how investors said they’re using smart-beta strategies. This year, 60% of respondents said they would use or would consider using multifactor products among available smart-beta strategies. There is often quite a bit of difference in the investment strategy and construction of these products across managers. Given these differences, investors may see a different set of benefits in this type of strategy from how a manager intends it to be used. Understanding how investors plan to deploy these products in a portfolio can help ETF managers fine-tune their messaging across other channels.
Were there any insights about practice management you found in the data?
We had some questions about how firms are thinking about portfolio construction. Most aren’t currently outsourcing it. But those that are outsourcing are showing a preference for third-party asset allocation models, basically a portfolio of ETFs. The consideration here, and an area of focus for managers and investors alike, is whether or not we’ll see some slowdown in production of both individual ETFs and more focus by ETF managers on generating models of their existing inventory, their existing ETF menu.
For a full report of our findings, visit bbh.com/etfsurvey.
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