ETF Investors Offer Their Feedback

December 01, 2017

[This article appears in our December 2017 issue of ETF Report.]

Our fifth-annual ETF investor survey follows on the heels of record inflows and continued surging popularity for the industry. Assets under management remain at record levels, having crossed the $3 trillion mark during 2017. And launches and closures are hovering around previous record levels, their rates indicating that ETFs continue to be a healthy and thriving industry.

In that context, we have again polled our sophisticated readership to learn their opinions on the leading issues faced by ETF investors today.

And once again, we have partnered with Brown Brothers Harriman—a leading provider of asset servicing for the global ETF market, which has more than $500 billion in ETF assets under custody as of Sept. 30, 2017—to update the survey to reflect the most relevant core topics and emerging new concerns, arriving at a comprehensive questionnaire that hits all the important areas.

We’ve gathered the results, and what follows is a summary of our most interesting findings.

We used a slightly different approach this year, doing away with number-based rankings, when it came to participants’ ETF selection criteria.

Expense ratio saw its importance jump. While it was always a key criteria, this year 64% of those polled said it was a “very important” factor in their ETF selection process. Last year, 55% ranked it as their first or second consideration. 

The same percentage last year ranked exact exposure of the underlying index as their first or second consideration (with 38% marking it as most important). This year, “index methodology” was the No. 2 criteria, with 52% describing it as “very important.

When asked about actively managed funds and how they evaluated such, 67% of respondents considered expense ratio to be very important, more than the 63% who deemed performance history very important.

The rising importance of expense ratios could be reflective of the spreading fee wars in the ETF space and an accompanying rise in investor awareness of costs. And the Department of Labor’s proposed fiduciary rule, while not fully implemented, has certainly raised a flag in the minds of financial intermediaries regarding costs. Indeed, when asked what they took into account when evaluating product costs, well over half of respondents listed fiduciary duty to clients as their primary consideration, followed by the drag on performance.

Interestingly, tax efficiency, which was ranked as one of the top three selection concerns by just 15% of respondents last year, was ranked as “very important” by 42% of this year’s participants, with another 46% ranking it as somewhat important. Coupled with the increased focus on expense ratios, it suggests growing concern and sophistication around the issue of cost effectiveness.

When asked what the areas were where they’d like to see more ETFs, one-third of respondents listed the alternatives space as one of their choices. Indeed, this is one of the smallest areas in the ETF universe, with only 61 funds out of more than 2,000.

Active management and international equity both came in with 26% of respondents selecting them. Both are areas that have seen a significant level of launches. International equity is down year-over-year, but still represents more than one-fifth of the year-to-date launches, while roughly 60 actively managed ETFs have rolled out this year, up from about 40 during the same time period last year.

In fact, the active and international spaces dovetail rather neatly, with the responses to the query of, in what asset classes would a participant seek out an actively managed ETF? Emerging markets equity was the top answer, selected by 54% of participants, up from 20% last year. It was followed by international equity, at 45%, which was up from 6% in the prior year.

Fixed income, which had been the place 42% of respondents said they were most likely to seek out active management, dropped to just 6%. The change likely reflects the uncertainty many see in the fixed-income markets and the widespread outperformance among non-U.S. equities.

This year was the first one in which we asked investors about the nature of smart beta. We asked them to decide whether strategy, or some hybrid of the two. Just 10% consider it to be passive versus the 25% who consider it to be an active strategy. Almost two-thirds of the respondents described it as a hybrid of active and passive.

When it comes to actual usage, 33% said they did not use smart-beta strategies in their portfolios; 24% said they used it, but that it represented less than 5% of their portfolios. Just 13% said smart-beta strategies represented more than 20% of their assets under management.

The other piece of that question—whether participants intended to increase, decrease or maintain their current allocation to smart beta—suggests a certain amount of entrenchment. The largest percentages went to those who said they would simply maintain their current exposure, while very few said they would decrease their exposure. A moderate amount indicated they would be increasing their exposure to those strategies.

The data suggest the 33% of investors who are not using smart beta have a great deal of trepidation and uncertainty about such strategies. More than one-third said they didn’t know if such strategies would outperform active management, while another third said they were simply unfamiliar with the strategies. Another 29% said smart-beta objectives could be achieved through internal portfolio management.

When it comes to how investors are making room for smart-beta exposures in their portfolios, 41% said they were replacing index ETFs with it, while 35% said they were replacing active mutual funds with it. Another 27% said they were reallocating to smart beta from other investments like stocks or bonds.

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