ETFs ‘Just in the Third Inning’

Nasdaq indexing chief John Jacobs provides the numbers behind continued explosive indexing growth, particularly in ‘smart beta’ products

Advisors who have watched the disruption ETFs brought about in their early days, and their explosive growth since, may be wondering if a market that in 2013 reached past $1 trillion in assets is now ready to slow down.

“Indexing has not run its course. We’re just in the third inning,” comes the reply from Nasdaq’s John Jacobs, who, in a highly-caffeinated phone interview with ThinkAdvisor, embodied the notion that ETFs won’t be slowing down if he’s in a position to do anything about it.

And, as the head of the exchange’s information products division, which creates and licenses indexes, Jacobs offers a key position in the ETF universe. He also manages to keep busy.

 “Two years ago I had 2,000 indexes; today I have 41,000. We rolled out 13,000 last week [in the global equities space],” says Jacobs.

So what does he see, from his perch atop the Nasdaq, that gives him confidence we’re just a third of the way through the game?

“We still have huge international markets to go. We have not exhausted asset classes outside of equities — in fixed income, currency and commodities. We haven’t penetrated defined contribution yet — there are only a handful of 401(k) plans that accept ETFs today. And pension plans and other asset owners who traditionally have had a consultant come in to manage the money are now demanding a combination of active and passive strategies — and we provide the passive,” Jacobs exuberantly details.

Nasdaq OMX is one of the titans of the indexing business, but its size has not slowed it down.

“We are probably the fastest growing of the major indexers," Jacobs says, noting a recent news report that its rival Standard & Poor’s expanded by a whopping 43% last year, but helpfully adding that Nasdaq’s exchange-traded product assets increased over 68%, from $54.9 billion to $92.3 billion, in 2013.

Nasdaq, whose claim to fame more than a decade ago was its QQQ index of the top 100 stocks on its high-tech-oriented exchange, has gone from that single index to 151 exchange-traded products today.

Within that large product pool, founded on traditional market-cap-weighted beta products, Jacobs says Nasdaq’s greatest growth has been in the smart beta area.

“This past year, one of the hot areas for us [has been in the] the dividend achievers,” he says. “We saw explosive growth as people were looking for yield. It’s a huge opportunity and that’s going to continue,” he says, citing Vanguard and PowerShares ETFs as licensees of these indexes, which group stocks with at least 10 consecutive years of increasing annual dividend payments.

Another growth area, also for yield-hungry investors, was its launch last year of BulletShares, an innovative fixed maturity corporate bond indexes.

“Say an investor wants a corporate bond with a 2020 expiration,” Jacobs explains. “A single bond involves huge risk. These are 200 bonds that all have 2020 expiration. You get same exposure you wanted, but it’s far more diversified, which is the true value of an index.”

Altogether, the Nasdaq’s dividend and income indexes increased over 68% last year.

While the exchange’s indexing chief is generally buoyant about ETF opportunities, the one area he was less than excited about was actively managed ETFs.

“I don’t think it’s going to grow so big; it’s not going to get a big foothold,” which, despite their rapid growth, remain at around $7 billion out of the more than $1 trillion in exchange-traded product assets.

Looking ahead into 2014, the index provider has about 40 new ETFs in its pipeline (both in the U.S. and abroad).

Jacobs is not saying what they’ll be — he doesn’t want to get ahead of his index partners like PowerShares, Vanguard, BlackRock and FirstTrust who will market the products — but he hints that “demand for nontraditional indexes is not abating at all.”

He also predicts that indexing aficionados will likely see some movement in the defined contribution area in the later part of the year.

With all this index issuance, it is interesting to note that Jacobs gives financial advisors some key credit for ideas.

“One-third of the ideas that end up in the marketplace come from indexers like us [through staff researchers]; one-third from our partners [e.g. BlackRock, ProShares]; and one-third from our customers—the financial advisors, the RIAs who say ‘I need this ETF.’

“We believe the financial advisor is one of the key target audiences for our indexes," Jacobs says. "They take the strategy and make them comprehensible and applicable for clients…They are the ultimate converter of thoughts about strategy into an index.”

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