2020’s Bright Spot: ETFs

[This article appears in our December 2020 issue of ETF Report.]

It’s early November at this writing, but really, the end of the year can’t come fast enough. With a global pandemic that has killed more than 1 million globally, a highly polarizing presidential race, and a bruised and battered economy, it’s hard to see the bright side of this calendar year.

But in the world of ETFs, 2020’s light shined brightly, astonishing given the pandemic’s devastating impact on markets and the economy in March. As the year moved into the second quarter, the long-anticipated arrival of the first nontransparent active ETFs signaled a banner day for the industry. The active model in all its disclosure stripes was complete, with the newest change making the ETF space more welcoming to active mutual fund managers.

Will this open the floodgates to mutual fund companies that have shunned ETFs for myriad reasons? A main sticking point had been the inability to replicate winning active strategies in an ETF due to traditional active ETFs’ frequency of disclosure.

We don’t have much proof that investors are itching to get their hands on traditional active management in an ETF wrapper. Instead, it seems issuers are the ones talking up this demand. Roughly a dozen ETFs of this type rolled out this year, but while reception was warm, it was also muted. It remains to be seen if the reason goes beyond the fact that they rolled out on very unsteady ground.

Industry Renovation?
But if they do take off, buoyed by the enthusiasm of those silent investors, it could reshape the industry entirely, drawing in mutual fund companies in greater numbers and bringing active management once again to the forefront. If they don’t, well, that seems like the blow that would permanently consign active management to a satellite strategy rather than the core of a portfolio.

Overall, the ETF industry is showing very healthy signs. Ten months in, the yearly record for closures has already been smashed to pieces, and there’s even a real possibility that the record for launches will also be broken by the year’s close. New ideas following failed ones is the key to innovation.

Innovation Pace Thriving
The ETF concept is in its late 20s now, staring 30 in the face. While it’s clear the pace of innovation in the industry is still thriving, Cinthia Murphy raises the question in this issue of whether ETFs have drifted too far from their roots. In Murphy’s article, Elisabeth Kashner of FactSet emphasized that, “There’s no question that launches have been much more focused on shiny objects or innovation, because asset managers are working hard to find opportunity in a very saturated market.”

I’m a big believer in index investing, and I think active management works best at the margins of a portfolio. With roughly $280 billion of new assets under management this year going into plain vanilla index funds, the roots of the ETF industry are as strong ever. The biggest ETFs in the industry are those plain vanilla, core exposure funds, with the more specialized and strategy-driven funds out on the edges.

But make no mistake: The innovation is going beyond the boundaries of the plain vanilla to embrace everything from risk management to ESG to niche themes and unexplored corners of the markets.