Kranefuss: 2 Crises Face Financial Advisors

June 01, 2016 What’s your take on the ETF industry today? We've seen a proliferation of thematic, very narrowly focused niche ETFs, and multifactor strategies coming in all shapes and sizes. Are we living through the “spaghetti-at-the-wall” phase of ETF development?

Kranefuss: There’s still room for product innovation. We know there are probably things out there that aren't there that we would like to have in order to build core portfolios in a disciplined way. But I would say there’s an awful lot of spaghetti against the wall at this point.

Many of the thematic ETFs come with a basket that plays into something that's currently being spoken about—the habits of millennials, or drones. That's no different than chasing hot stocks. There's often no investment hypothesis behind it, and they may be, in fact, taking on an extraordinary amount of risk.

I think the industry has gone off in a bad direction here. I liken it to people trying to write hit songs. They're catchy. But they’re trying to come up with thematic ideas rather than provide building blocks that work.

If you look over into the institutional space, where people have a bevy of advisors and institutional asset managers, you don’t see them really using these strategies. They're looking for tool kits. Today people can easily construct a portfolio that has an institutional-quality core strength with existing ETFs, but the industry is devolving into spaghetti against the wall, in many cases. Asset flows into ETFs this year have been a lot slower than last year. Should we expect a slower growth pace for ETFs, or is this linked to market performance?

Kranefuss: It's been a slow start all around the world, for the reasons I described. You have a bit of a perfect storm here. There’s quite high volatility in equity markets, but in a way that people are not accustomed to. Usually, volatility is synonymous with markets moving downward. And what we've seen essentially is a sideways market for the past three or four months, depending on where you are. But sideways here means up 4%, down 5%, and the like. It’s significant.

People are paralyzed because they fear getting caught in long-term bonds and having rates go up, and being stuck with the lowest bond income yield for the next 30 years, or a capital loss that's substantial. They also fear taking on more credit risk to try and get more out of the bond market. And they fear going into equities because they just look at their local market and see that it’s not stabilizing but kind of wandering around.

These are exactly the sorts of times when you don’t want to stick to an old asset allocation formula that worked in the past; you have to think about how assets and exposures might fit together in different environments. There are a lot more parts and tools that are available today. It’s challenging to understand, and it’s very challenging to do it yourself. On a personal note, do you still have your role at Source and at Warburg Pincus?

Kranefuss: Yes. I'm the executive chairman of Source. Last year we gained share; I think we're No. 5 or 6 in Europe. It's actually been very beneficial for me to be able to see things from the other side of the Atlantic. And I'm still involved in that capacity with Warburg Pincus. Is there any conflict to having a role in an ETF issuer and having a role in an investment management firm that builds ETF portfolios?

Kranefuss: I don't believe so. We're an open architecture platform. We're going to pick the best ETFs that serve the needs of clients. Not one ETF provider provides everything you need. You want diversification across providers. And so, as chairman in both cases, I'm not making decisions on this one, that one, the other. And it does me no good to spin it one way or another, even if I could. But really there's no need to do that. This is a different end of the business. That's why I think an awful lot of the value is shifting in the industry.

To your point about spaghetti against the wall, I think that one of the things we've noticed is the barriers to entry in the ETF market are relatively low. You can get an ETF up and running for a few hundred thousand dollars. But the barriers to success are getting quite high. There's a lot of value shifting now toward what you do with all these ETFs, and which ones you should consider putting into a portfolio.

Contact Cinthia Murphy at [email protected].




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