[This article appears in our December 2016 issue of ETF Report.]
2016 has been a wild ride for the markets, but assets have flowed into ETFs nonetheless. As the still-young industry has evolved, every year brings major changes and surprises. At ETF Report, we have a front-seat spectator’s view on the ever-changing shape of the ETF space, so what follows is a rundown of our key expectations for the coming year.
From the asset classes we expect to thrive or flounder, to the trends and strategies that we see coming to the forefront, these are our best-educated guesses for what the new year will bring, along with the evidence and data upon which we’ve based those predictions.
FURTHER BLURRING OF LINE BETWEEN ACTIVE & PASSIVE
Actively managed ETFs have yet to gather any significant traction. Of the nearly 2,000 ETFs listed in the U.S. today, less than 10% are actively managed. Combined, they represent less than 1% of total assets under management.
These are small numbers. And 2017 isn’t going to be the year when the tide finally turns for these strategies.
Instead, what we see happening next year is the further blurring of lines between active and passive, with ETFs coming to market that try to combine the best of both worlds into one single wrapper.
Cases In Point
Consider the Elkhorn Fundamental Commodity Strategy ETF (RCOM) as a great example of this trend. Just launched in September, RCOM is officially listed as an actively managed ETF. But at heart the fund is an index-tracking strategy that has an active element to it.
RCOM tracks the Dow Jones RAFI Commodity Index, which is a broad commodity benchmark, but it seeks to capture added returns by actively managing on the side by investing the fund’s collateral in things like U.S. government debt, corporate bonds and money market instruments. In the end, RCOM is labeled an active ETF, but it will be the passive commodity index that will likely dominate its returns.
Another example? The WisdomTree Managed Futures Strategy Fund (WDTI). The ETF is actively managed, but its prospectus specifically states its objective: “The fund is managed using a quantitative, rules-based strategy designed to provide returns that correspond to the performance of the WisdomTree Managed Futures Index—the ‘Benchmark.’” WDTI is an active ETF that’s looking to match a benchmark.
SYLD is an actively managed ETF that picks and weights stocks based on a company’s cash flows. FYLD, meanwhile, strives to offer similar exposure in developed-market non-U.S. equity, but it does so by tracking an index of 100 equally weighted stocks.
It could be argued that SYLD might be active in name only because of its particular exemptive relief rules. Both ETFs follow similar rules-based methods from the same issuer, but they are each applied to U.S. and foreign markets, respectively. In other words, SYLD and FYLD differ due to happenstance of their exemptive relief based on their geographies. Essentially, they are only active and passive, respectively, because of a difference in rules.
The Smart-Beta Element
And these are just a few examples. Elsewhere in the ETF space, this blurring of lines is also seen under the increasingly broad umbrella of smart-beta funds.
Some passive smart-beta ETFs take a lot of active risk—think single-factor funds with few portfolio constraints that stray significantly from marketlike exposure, for example.
They may be passive in name, but they’re more like active ETFs than you might think.
At the end of the day, we’re talking about an ETF market that no longer can be split solely into two—passive versus active.
“The blurring of lines means there’s a continuum of passive to active exposure and risk beyond binary labeling of active and passive,” said Paul Britt, ETF analyst with FactSet.
Going forward, we’ll continue to see new ETFs challenge this long-standing labeling practice.