ETFs' Future: Huge Growth

February 04, 2014

Or if you’re a bigger player, you can decide to dial it up a notch, and take advantage of some of the innovation in the space. You can anchor yourself in U.S. equity with the iShares Quality ETF (QUAL | A-68), the one they developed for the Arizona Retirement System, talking almost a Warren Buffett approach to the market.

You can get your international equity exposure abroad with a currency-hedged wrapper, to protect against a falling euro (DBEF | C-51). You can tilt toward the dividend payers in emerging markets (DEM | D-76), and layer on direct Chinese A-share exposure (ASHR), because A-shares are trading at a discount to H-shares for the first time in a generation.

Then in the bond space, you can hire Bill Gross to run the bulk of your portfolio (BOND | B), layer in senior loans (BKLN | B) and a short-term high-yield bond play (SJNK | C-98). You can buy hedged and complete international bond exposure (BNDX), get one of the best commodity funds on the market (DBC | B-69) and you can do all that for 39 bps.

Or you can hire a firm like Wealthfront—a well-funded startup in Silicon Valley that offers very-well-built portfolios of ETFs, managed by investing legend Burton Malkiel, with constant tax-loss harvesting and no trading or custody costs. For the first $25,000 you invest with Wealthfront, it charges exactly 0.00 percent in fees. It charges 0.25 percent for everything above that.

All of these aspects are making ETFs truly and universally attractive to retail investors for the first time. And it’s going to make assets soar.

Concerns

Not everything is completely rosy, however. ETFs are in a gold-rush phase at the moment. And in a gold rush, anyone can show up by the side of the river with a pan.

This makes us nervous. We have four big concerns that we think could hinder the growth in the ETF industry.

Toxic Products

With product proliferation comes the ever-increasing chance that people end up in products that don’t do what they think they’ll do. The industry is in general well-regulated and pretty good at labeling, but there are still many opportunities for confusion.

Take products that invest in futures, for example, like the iPath S&P 500 VIX Short-Term Futures ETN (VXX | A-54). VXX does exactly what it says it’s going to do—tracks a blend of short-term VIX Index futures. But many advisors have piled into VXX thinking it will be a medium- or long-term hedge against downturns in the U.S. equity markets.

In fact, since its launch in 2009, VXX has lost nearly 100 percent of its value due to contango in the futures market. Similar things have happened to investors trying to track heavily contangoed markets like natural gas. These products can poison the well with retail investors and advisors, and the industry will need to maintain a serious focus on education to avoid blowups and bad headlines.

 

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