Dave Nadig's 2018 Bold ETF Predictions

It’s that time of year—the time when market prognosticators, sports enthusiasts and political pundits start making impossible-to-verify predictions about what the coming year will bring. In the spirit of that, here are a few of my bold and not-so-bold predictions for 2018.

1. Some fairly boring smart-beta stars are born

I’m not in the market-prediction business, but I can’t help but feel like the broad equity markets are … frothy. I’m not talking about a giant market crash or anything, I just look at the chart of the S&P 500 and it looks pretty unrelentingly “up and to the right.” Even things like the CAPE ratio are looking hard to ignore (and sure, I know all the counterarguments).

So what happens if there’s a real pullback? Well, we know that, short term, anything that’s got a low beta will all of a sudden start racking up nice relative performance numbers. Who knows who the precise winner might be, but the general characteristics are probably:

• Funds that have been around at least three years, and even better, five
• Funds that are pretty “marketlike” but still with a consistent beta below 1.
• Funds that generally stay well-diversified by design

To me, that list includes funds like the iShares Edge MSCI USA Quality Factor ETF (QUAL), or even something like the Guggenheim Defensive Equity ETF (DEF). Many smart-beta newcomers are actually pretty high-beta plays, so the prevailing logic that they’ll all do great seems misguided to me. (You can check out the beta of any ETF versus a neutral benchmark on the FIT tab of our fund pages.)

2. It’s not the big resurgence of active

It’s pretty simple, really. In a big downturn, some decent chunk of active managers will outperform, if for no other reason than they’ve been sitting on cash when an “event” occurred.

But we have numbers that tell us just how well they did. Longtime readers will know I’m a big fan of the S&P Index vs. Active report (SPIVA), which measures “what percent of managers were beaten by their benchmarks.” Here’s what the report said at the end of 2008:

     “The belief that bear markets favor active management is a myth. A majority of active funds in eight of the nine domestic equity style boxes were outperformed by indices in the negative markets of 2008. The bear market of 2000 to 2002 showed similar outcomes.” 

And here’s the data to prove it:

Source: Standard & Poor’s Indices Versus Active Funds Scorecard 2008

So, I just don’t buy it.

3. Nontransparent active? OK, this time I really mean it …

Look, I get it. I’ve been saying for literally years now that “this is the year it finally cracks” for the nontransparent ETF active structures. But … but … this time we have a new, perhaps more industry-friendly head of the SEC in Jay Clayton, and his new head of the Investment Management division, Dalia Blass, is so well-liked that the ICI even put out a happy-dance press release when she was appointed.

While most of the speculation has been about whether we’ll finally see comprehensive ETF regulatory cleanup or the fate of bitcoin ETFs, I think good news may finally be in the cards for the likes of Precidian Investments, which has been waiting for years for movement on its clever nontransparent structure.

4. ESG trickle continues

While it’s true that environmental, socially responsible and governance (ESG) didn’t take the world by storm from an asset-gathering perspective, they didn’t go nowhere either. There are currently only 33 pure ESG funds on the market by my count, and they collectively pulled in over $800 million in 2017 … and literally not one of them suffered outflows.

I expect 2017 to not only feature more launches, but a slow and steady pickup of assets from all three pillars of the ETF distribution temple: retail, advised and institutional. And the big news may just be on the fixed-income side of things.

5. The continued patterns of ‘Cheap Wins’ and BYOA

Eric Balchunas of Bloomberg calls this a “bring your own assets” market, and I agree. Look at the list of relative newcomers that’ve all had pretty decent-flow years: John Hancock, Nationwide, Legg Mason, Oppenheimer, Transamerica—all firms pulling hundreds of millions into funds we don’t generally write about every day. These are firms with entrenched distribution systems bringing either internal assets or traditional wholesaling teams to bear on ETFs, and we’ll see that model continue to work.

On the other hand, it’s hard to miss that the top of the leaderboard is dominated by low-cost beta from Vanguard, iShares and Schwab. The cost message has gotten through, loud and clear, and at this point it’s reasonable to expect a few-hundred-million a year tail wind of continued flows coming into ETFs for the first time, abandoning high costs in other non-ETF structures.

6. Flows?

And as for the overall flows? I don’t think we top this year—not if I’m right about the market being a bit more turbulent. But I bet next year is within shooting distance, and north of $250 billion in net new money.

Of course, I could be wrong: 2018 might be another rocking bull market on the back of tax cuts; in which case, Katie-bar the door!

At the time of writing, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].