Innovation Is Unpredictable

April 03, 2018

{This article appears in our April issue of ETF Report.]

The annual Awards Dinner is always an exciting event.

Sure, it’s great to see old friends and make new ones, but more than anything, I think it’s a great opportunity to see where ETFs, as an industry, are headed. One thing’s for sure, however: No matter what I might predict, I’d be guaranteed to be wrong.

Just consider how wrong I’d have been if I’d tried to predict the ETF of the Year nominees this time last year. Would you’ve guessed we’d have everything from a plain-vanilla bond fund (the Vanguard Total Market Bond ETF (BND)) to a bespoke approach to China that removes the influence of central planning (the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (XSOE)?

I certainly wouldn’t have predicted we’d see political-themed ETFs—DEMS, GOP, TAXR—all over the lists. But that’s the world we live in.

Looking Ahead
So, what’s next then for the ETF industry? I’ve been on the record saying I think ESG will continue to be important, and sure, we’ll see more ETFs targeting ESG-conscious investors, and we’ll see more focus on governance and stewardship from the big players. But I think the biggest innovations in ETFs in the coming year will probably come from outside the industry itself—and those innovations may prove disruptive.

Consider direct indexing. Robo advisor Wealthfront didn’t come up with the idea, which centers on tax-loss harvesting, but in 2013, it brought it to otherwise-ETF-focused audiences. Its pitch was simple: If you have a bit more than walking-around money, instead of buying ETFs, you can just buy single stocks, and take advantage of your single-stock losses more efficiently, lowering your tax bill in exchange for some small amount of tracking error.

Taking Off
It’s not a brand-new idea—the world’s wealthiest have done this for years. But bringing it down to accounts with just $500K was a new idea. And it’s one that’s catching on. Firms like Robust- Wealth, Smartleaf, Parametric Portfolio Associates and Personal Capital all have their own takes on this, and it could have a big impact on the ETF space in years to come. ETFs are, after all, just a wrapper for investment ideas. They’re a great wrapper—probably the best anyone’s ever come up with—but the true value of any investment is in its exposure, not the wrapper.

Direct indexing could change things up, putting more focus on the way an index is constructed and how individual portfolios are optimized to that index, and less focus on issuer brands, the fee war and the ins and outs of ETF trading.

Should we all be quaking in our collective boots? Probably not. But it’s worth paying attention. The smartest players in this game will be ready for a shift in the playing field, and ready to adapt—no matter what the future brings.


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