[This article appears in our December 2019 issue of ETFR.]
It was another busy year in the ETF industry, and aside from the usual flurry of new ETF launches, there was a welcome regulatory change.
The summer also brought some stock market bumpiness that had more than a few people wondering if the markets would repeat 2018’s fourth-quarter swoon.
Looking back at the year that was, industry watchers explained what stood out for them.
ETF Regulations Modernize
Industry watchers are applauding the new ETF Rule passed by the Securities and Exchange Commission, which provides a more consistent ETF regulatory framework and improves transparency.
“I think the new rule is a bigger deal than people say it is,” said Briefing.com’s Senior Market Analyst Brett Manning. “I think it opens the floodgates to a lot more creativity and innovation, and it lowers the cost.”
Others agree. Carlton Neel, CEO of Chaikin Analytics, notes that this could allow ETF issuers to launch more active and targeted funds: “It’s really all about how can I as an investor access the market in ways that give me a chance to make a very specific decision on where I want to put my money?”
Manning suggests fund issuers may ratchet up marketing of the new ETFs they’ll be able to create. He says that if you combine more marketing with more creative and innovative ETFs, that could pull retail investors back into the stock market—a segment of investors he believes is largely absent. “It could make an enormous difference in terms of the market [ETF issuers] get,” he said.
Neel thinks this could open ETFs to the liquid alternatives space, which he calls “one of the holy grails of the investment space. … I think you’ll start to see ETFs that have the ability to do some things that previously you haven’t seen in the ETF landscape.”
A lot of discussion centers around leveling the playing field, but Nate Geraci, president of The ETF Store, observes that the rule didn’t address share class structure, including how Vanguard structures its ETFs. “They don’t have to abide by everything in the ETF rule. … I don’t think it’s a huge deal, but maybe [it’s] something that got lost in the shuffle,” he noted.
Still No Bitcoin ETF
The SEC shelved approving a bitcoin ETF, but sources say they weren’t surprised. Geraci believes there’ll be a bitcoin ETF by 2020, but that it may need a change in SEC leadership to happen.
“There’s been some speculation that as long as Jay Clayton is SEC chairman, a bitcoin ETF will never come to market, because if you read between the lines on many of the comments he’s made, he just doesn’t seem sold on crypto and bitcoin yet,” he explained.
As concerns about bitcoin fraud and spot market manipulation remain, it’ll be tough to get a bitcoin ETF approved, Geraci admits. Yet he thinks there’s enough incentive for ETF issuers to pursue a bitcoin ETF, considering a vehicle like the Grayscale Bitcoin Trust has almost $1.5 billion in assets under management (AUM), charges a 2% annual fee, and trades at a 14.5% premium to net asset value as of early November.
“I think we’re going to continue to see this back-and-forth dialogue between ETF issuers and the SEC,” Geraci said.
The Grayscale fund may show there’s demand for a bitcoin ETF. Todd Rosenbluth, director of mutual fund and ETF Research at CFRA, points out the blockchain ETFs, which may be considered proxy bitcoin ETFs, haven’t benefited from the interest in bitcoin.
Of the four blockchain ETFs, only the Amplify Transformational Data Sharing ETF (BLOK) has around $100 million in AUM as of November. Most blockchain ETFs performance matches the SPDR S&P 500 ETF Trust (SPY), but these niche ETFs also charge a much higher expense ratio.
Rosenbluth notes that many of the blockchain ETFs came out about a year ago, but just haven’t gained traction: “I think bitcoin is less top of mind for the average investor today versus a year,
a year and a half ago.”
Cannabis ETFs Sprout Like Weeds
2019 saw five cannabis ETFs launch, joining the first one to debut, the ETFMG Alternative Harvest ETF (MJ). MJ once had $1 billion in AUM, but early buyers to these ETFs have been burned by poor performance. Manning says that people are still trying to figure out how to take advantage of what looks to be an obvious growth theme. He thinks cannabis may end up acting like any other commodity market.
Kip Meadows, CEO of white label ETF issuer Nottingham, whose firm helped launch the Amplify Seymour Cannabis ETF (CNBS) and The Cannabis ETF (THCX), thinks cannabis is like other industries that saw excess enthusiasm at the start and then get oversold.
He believes despite the poor performance so far of the cannabis ETFs, the industry will eventually take off. More states are approving some type of cannabis use, and if federal approval occurs, Meadows says, “it’ll be great for the industry.”
He points out there are differences between the six funds: Some are broad-based indexes and others pure-play active funds, but not all will survive: “I think several will survive for people who pay attention to what’s actually in them.”
Volatility Returns, Sort Of
A bout of volatility during the summer was driven by concerns over slowing global growth and a ratcheting up of the trade war between the U.S. and China that renewed worries about a recession, especially as the yield curve inverted. Both Geraci and Rosenbluth point to how low volatility ETFs like the iShares Edge MSCI Min Vol U.S.A. ETF (USMV) and fixed income ETFs benefited from this nervousness. They consider the asset flows to these two types of ETFs one of 2019’s biggest trends.
Geraci comments that this market behavior is unusual given that the S&P 500, through the beginning of the fourth quarter, was up 20% and near record highs.
“Bonds are having a strong year, and just about every major asset class across the globe is positive. But there’s this fear that continues to pervade the markets,” he said, suggesting this is spillover from 2018’s fourth-quarter sell-off.
Andrew Folsom, senior investment analyst at Wells Fargo, agrees, noting that demand for low volatility ETFs picked up in the fourth quarter of 2018 and never stopped in 2019. That desire for stable equities pushed investors into U.S. large cap blend ETFs, which were on track for a record year of inflows: “Demand for low volatility has been a huge influence.”
Rosenbluth and Folsom also point to the record demand for fixed income ETFs as a group. Rosenbluth notes that this stands out, because this asset class saw more inflows than equity ETFs—the first time that’s happened in a decade—even though fixed income ETFs represent 20% of the overall ETF asset base. Plus, it comes at a time when the Federal Reserve lowered rates and the 10-year U.S. Treasury note fell sharply.
Folsom observes that fixed income buyers took on more risk, whereas equity buyers didn’t.