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ETFs’ Future Debated by Top ETF Players

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ETFs are old hat by now, right?

Well, that may be so, but the solidity of their investment industry footprint and the vastness of the investment terrain as yet still unconquered mean investors should brace themselves for another innovation-fueled wave of growth in exchange-traded funds.

Advisors perhaps jaded by the incessant breathlessness that has been the hallmark of these uniquely diversified, tradable, tax-advantaged and generally low-cost funds got a fresh dose of starry-eyed optimism at a future of ETFs panel Monday at ETF.com’s InsideETFs annual conference in Hollywood, Florida.

Vanguard investment strategist Joel Dickson was first to snuff out any potential thoughts of premature aging, telling a packed hall of financial advisors:

“We did research a couple of years ago [that found that] when investors were given a choice between ETFs and funds of a similar type, they were three times more likely to invest in an ETF if they had previously owned an ETF.”

Given a mere 10% investor penetration, the “familiarity effect” Dickson found augurs further expansion as more investors come to know and love the products.

State Street’s Nick Good also noted the “long runway” ETFs still have from a market-penetration perspective, with 1% of the total global fixed income market invested in ETFs and 4% in ETFs on the equities side.

But it’s not just that there’s room for growth; there are factors fueling that growth, such as corporate alliances promoting ETF investment, including State Street’s new partnership with DoubleLine in the actively managed fixed-income space and Fidelity’s partnership with BlackRock.

On the innovation side, Invesco PowerShares’ Dan Draper predicted that “smart beta and high conviction alpha is where things are going to move,” specifying that ETFs, with their lower-cost structure, will be able to “target those active managers providing beta [i.e., closet indexers] at high cost.”

IShares Institutional’s Daniel Gamba shared Draper’s view that innovation will fuel the next wave of ETF growth, saying “when you have industry at $2 trillion, relative to $1 trillion a few years ago, the one-size-fits-all model is gone; people are looking at different uses.

For Gamba that means there will be a greater development of active ETFs and increasing derivatives applications, using ETFs as vehicles to replace futures and swaps.

Precision, in the international sphere, means that investors need not buy a whole package of, say, high-risk emerging markets if they want to fine-tune risk and reward more precisely.

In the same way that one could not buy or short Switzerland before ETFs brought about a targeted Switzerland fund, so too can investors today buy India individually rather than a broader emerging markets fund.

“Who’s going to benefit from lower commodity prices and oil?” Gamba asks. “If you have active views regarding different markets, ETFs are the way to go.”

Fidelity’s Tony Rochte had an entirely different take on what will fuel ETFs’ growth, focusing more on the demand side than the supply side.

“These are no longer EFTs — electronic fund transfers — but ETFs,” he joked, saying that until now institutions and advisors accounted for over half of all ETF buying, but that going forward “I do think the retail investor is the one to watch.”

The Fidelity exec, whose firm is offering commission-free trading on dozens of ETFs, asks: “Does the advisor now get reverse inquires [from the client]?” If yes, that will drive the next growth phase.

Another panelist dispute concerned smart beta, with Invesco PowerShares’ Dan Draper, an early adopter of Research Affiliates’ RAFI smart beta indexes predicting some 35% growth over the next three years, nearly matching the firm’s 44% increase in smart beta AUM over the past three years.

Smart beta foe Joel Dixon of Vanguard shot back “There you go again, Dan,” echoing a phrase from the Reagan-Carter debates.

Besides defending the results of market-cap-weighted indexes — “it is where buyer and seller voluntarily agree on price” — Dickson also offered an unflattering acronymic definition of smart beta: “Silly Moniker for Active Rules-based Trading.”

And as the panel’s focus was the future of ETFs, no advisor conversation about the future, or about ETFs, can go long without reference to the robo-advisor challenge, which Guggenheim’s Bill Belden discussed with surprising sanguinity:

“Robo-advisors will be a great accelerant to investor education for the masses … will build more efficient access to asset allocation solutions … and ETFs will be the beneficiary of that — [robo-advisors will] accelerate the pace of adoption of ETFs.”

Fidelity’s Rochte agreed, citing his firm’s partnership with Betterment and adding that robo-advisors “are focused almost exclusively on millennials,” and as such are bringing a new generation of advisory clients into the marketplace.

While the six panelists approached ETFs’ future from varying perspectives, a consensus of laughter to a comment by Nick Good underscored agreement on the investment vehicle’s still bright prospects.

The State Street exec recalled a meeting during an earlier consulting gig he had with Barclays Global Indices when one of his colleagues commented:

“When is somebody gonna shut down this iShares thing? It’ll never make money.”

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