What will be the biggest trends that shape ETF investing in this year? Here’s a short list of megatrends, which reflect a host of 2012 developments and future possibilities:
1. Proprietary indexes from bigger ETF firms
For years, smaller ETF providers like IndexIQ and WisdomTree have purposely avoided using indexes from well-known companies like Dow Jones and Standard & Poor’s in favor of their own customized indexes. Now that trend is starting to resonate with larger ETF providers.
In October, the Vanguard Group turned heads when it said it was switching index funds and ETFs with aggregate assets of $370 billion to new benchmarks developed by the University of Chicago's Center for Research in Security Prices (CRSP).
Vanguard’s abandonment of MSCI indexes in favor of alternative benchmarks is paving the way for a new direction. Because of sharp reductions in ETF expense ratios, fund providers have no choice but to cut index-licensing fees to keep assets from fleeing to lower-cost competitors.
2. Mutual fund providers invade ETF market
Brisk activity in SEC filings for proposed ETFs in the final month of 2012 shows that several big hitters in the mutual fund world plan to make their impression in the ETF marketplace.
T. Rowe Price, according to filings, plans to launch its first ETF — an active total return bond fund that emphasizes income. The proposed ETF is called the T. Rowe Price Diversified Bond ETF, and the fund would apply the company’s proprietary selection method, based upon the firm's fundamental and quantitative research.
Along similar lines, Franklin Templeton revealed plans to introduce an actively managed ETF that holds short-duration government bonds. The proposed fund is named the Franklin Short Duration Government ETF and it will own a diversified basket of short-duration, fixed-income securities issued by the U.S. government and related agencies.
Although not new to the ETF market, another noteworthy trend is an ETF menu expansion by Fidelity Investments. The company is planning to offer the Fidelity Corporate Bond Fund, along with a series of other actively managed bond.
3. Active ETFs galore
For most of its existence, the ETF landscape has been dominated and out-numbered by index-based products, but fund providers are focusing their efforts on adding actively managed funds to the mix.
The successful launch of the PIMCO Total Return ETF (BOND) in 2012 has provided other fund families with a model to follow. The “all weather” bond fund has already amassed almost $4 billion and is run by manager extraordinaire, Bill Gross. Not only has BOND outperformed its mutual fund counterpart with the same name, but it charges lower expenses of just 0.55%.
“Get used to them," said Joshua Brown, a financial advisor at Fusion Analytics, about active ETFs. "They'll only get bigger and siphon more cash from their elders in the mutual fund world.”
4. Fiduciaries running ETF retirement plans
“In the retirement industry, the big trend for ETFs is with 3(38) investment managers,” notes Darwin Abrahamson CEO and Founder of Invest n Retire. Abrahamson’s Portland, Ore.-based firm offers an electronic platform that facilitates ETFs inside 401(k) plans.
ERISA Section 3(38) is an “investment manager” acting as a fiduciary because they take discretion, authority and control of a retirement plan’s assets. ERISA rules allow retirement plan sponsors to assign the responsibility (and significant liability) of selecting and monitoring of investments to the 3(38) investment manager fiduciary.
A 3(38) fiduciary can only be a bank, an insurance company, or a registered investment adviser (RIA) operating under the Investment Advisers Act of 1940.
5. Continuation of fee wars
Cutthroat investment management fees have been a blessing for investors, and in 2012, we saw sharp fee cuts in ETF expense ratios from Charles Schwab, iShares, PowerShares, Vanguard and others.
This theme will continue into 2013, especially as fund providers shift to eliminate or reduce their index-licensing fees. Furthermore, commission-free ETF trading has intensified the battle.
Finally, I’ll give you one more megatrend as a bonus: ETFs inside 401(k) plans.
There have been many attempts to push ETFs in 401(k) plans, but I expect Charles Schwab to come through with an aggressive ETF(k) plan that will force competitors to respond. Thus far, the ETF(k) movement has been a unhurried moving trend that I liken to the slow evolution of digital publishing.
However, what began as a small and isolated movement is now the unquestionable future. And that’s how ETF(k) plans will someday be.