It’s no question that exchange-traded funds have become increasingly popular.
Shundrawn Thomas, head of the funds and managed accounts group at Northern Trust Asset Management, believes this trend will continue.
“This is not a passing fad. This is not cyclical in nature,” he told an audience at the Inside ETFs conference in Hollywood, Florida.
Speaking specifically to advisors and individuals who build portfolios for investor clients, Thomas outlined what he considers five “irrefutable” trends that will “definitively” increase advisors’ utilization of ETFs:
1. The retirement savings gap
Individuals are living longer, and the number of individuals with defined benefit plans has dropped. In addition, investment return expectations have greatly fallen.
“We went from a period of time in the previous 40 years where real returns in the equity markets were 7% … and our expectations today range from 4.5-5%,” Thomas said.
All of these things have led to what Thomas refers to as “the retirement savings gap.”
“Investors have set far too little aside to meet their investment goals or expectations,” he said. “If you’re in the investment advisory business … this suggests a significant opportunity for those that are effective providers in this business.”
The reason Thomas believes this will lead to an increased use of ETFs is largely because of the built-in benefits of these funds – in particular, transparency.
“If you’re an advisor, transparency can … provide an enhanced level of trust,” Thomas said.
He added that simple, accessible and transparent investment vehicles can help build trust “in a world where people are trusting all things – including their financial advisor – less.”
2. Long live fixed income.
In 2016, according to Thomas, there were record inflows into fixed income ETFs at $82 billion. ETFs are also increasingly taking share from fixed income mutual funds.
“There are certain prevailing trends which drive flows into fixed income that have nothing to do with interest rates or the cyclicality of the environment,” Thomas said.
Thomas attributes the drive into fixed income to an increasing demand for income generation, risk mitigation and the ability to preserve capital.
“Think about the fact that we had baby boomers begin to retire in 2011, and, as that increases, we have more and more needs for income,” Thomas said. “Think about the fact that, counter to prior generations, millennials are actually more risk averse in their investment strategies. So they are actually using fixed income strategies more than we would have predicted they would.”
Institutions, Thomas said, are using fixed income to offset or hedge liabilities or in some ways inoculate their exposure to certain liabilities altogether.
ETFs in particular are in demand as a fixed income vehicle because they provide liquidity and trade on exchanges which can offset fixed income’s “highly illiquid” qualities.
“Without question we will be using more fixed income ETFs in portfolios,” Thomas said.
3. Demographic disruption
Thomas identified several demographic changes that are starting to disrupt the advisory market, including generational, geographical and gender.
Advisors’ marginal clients are changing from a baby boomer to a Gen Xer and a millennial, which has “dramatic implications for how you serve them and how they invest,” Thomas said.
In addition, the growth of wealth is shifting geographies.
“We have decelerating GDP growth in developed countries like the U.S., like Europe, like Japan, and accelerating GDP growth in emerging economies like Asia-Pacific or Africa,” Thomas explained.
Meanwhile, wealth is also starting to shift hands from men to women. In the U.S., women now own 51% of private wealth. Globally that number is 30%, up from 25% in the last five years.
“If you are an advisor, that means your marginalized client is going to be younger, they’re going to likely be from another nationality, they’re going to be ethnically diverse, and they’re going to be a woman,” Thomas said.
What does this mean for ETFs? According to Thomas, research and surveys show that all of these changing demographics “actually prefer ETFs.”
“You see them investing in them in greater proportions,” he said. “This is why it is an irrefutable trend and why we’re going to see more investments in those types of vehicles.”
4. A drive toward investment efficiency.
While there is “ad nauseam debate” about active versus passive investing, Thomas sees the underlying trend as a relentless drive toward investment efficiency.
“We want the maximum amount of results for the least amount of effort,” Thomas said. Adding, “In this drive toward investment efficiency … prudent investors are going to be increasingly focused on things like optimizing risk and return.”
ETFs are increasingly giving advisors the “wherewithal and the ability” to do this better, according to Thomas.
“There are certain ways that I can get exposure traditionally to size or value, some of them are what we call active management,” Thomas said. “If you’re [investing] efficiently in an alternatively weighted index strategy, the practical reality is oftentimes you can get that risk exposure more efficiently, with less effort and less [wasted cost].”
5. Man plus machine.
“If you look within financial services, we’ve been relatively slow to really adapt to many of the benefits offered by technology,” Thomas said. “In an asset management we’ve been particularly slow.”
Recently, robo-advisors have started to proliferate the industry. But Thomas stressed that advisors shouldn’t be concerned about the argument of “man versus machine” but rather “man plus machine” – calling for the integration of human intelligence and artificial intelligence.
Thomas believes this increasing use of technology among advisors will lead to an increasing use of ETFs.
“When you step into a digital investment advisory world, ETFs, relative to the other choices available today, are simply a better tool or building block to use,” he said.
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