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Portfolio > ETFs

What Does 2020 Hold for ETFs?

By Bernice Napach

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This year could prove to be interesting for ETFs because of regulatory changes and the proliferation of commission-free trading, but not necessarily a transformative one.

Now ETFs that don’t disclose their holdings on a daily basis will be able to come to market following Securities and Exchange Commission approval of their underlying structure. Whether investors will buy these nontransparent ETFs is a question.

“The problem [these ETFs] will wind up solving is an asset management one concerning transparency. Investors don’t really care,” says Ben Johnson, director of global exchange-traded fund research at Morningstar. But even asset managers may not benefit much.

Smart beta ETFs may have already eaten up much of the demand for such products, says Eric Balchunas, senior ETF analyst at Bloomberg Intelligence. The SEC has given several companies final approval for nontransparent ETF structures: ActiveShares, T. Rowe Price, Fidelity, Natixis and Blue Tractor.

American Century, which has licensed the ActiveShares strategy, could come to market with two such equity ETFs — large-cap value and equity growth — as early as the first quarter.

The SEC also approved a rule that will make it easier for asset managers to launch new ETFs because they will no longer have to file for exemptive relief under the Investment Company Act of 1940 for every single fund they want to launch.

The ETF modernization rule, which took effect the last week in December, also allows all fund sponsors to use ­in-kind (“custom”) baskets of securities and assets in the creation and redemption of shares, which analysts say should enhance liquidity.

Investors could benefit from the requirement that these traditional transparent ETFs publish their full portfolios daily on their website and disclose historical premiums and discounts to net asset values as well as bid-ask spreads.

This SEC ETF rule, also, is expected to be “most consequential for asset managers” rather than investors because they will be easier to launch, says Dave Nadig, managing director of ETF.com.

Leveraged and inverse ETFs also may have an easier time coming to market if a new proposed SEC rule is finalized. The proposal would extend the new modernization rule to those funds. The proposed rule also standardizes the framework for ETFs and mutual funds that use derivatives.

All these changes will likely mean that investors will have more ETFs to choose from but will need do their homework to understand their strategies, says Todd Rosenbluth, director of ETF and mutual fund research at CFRA, an independent research firm. He adds that liquidity of leveraged ETFs will matter more than their expense ratios.

What Will Spur ETF Growth?

Even before these changes take effect, flows into ETFs have been growing at a brisk pace while mutual funds overall have been experiencing outflows. Net inflows into U.S. ETFs rose to $264.3 billion through Nov. 30, just slightly below the $264.7 billion pace for the same time last year, according to ETF.com. But U.S. ETF assets, near $4 trillion, remain just 20% of U.S. mutual fund assets.

Also the net new number of ETFs as of the end of November was 109, which suggests that U.S. ETFs could be the lowest since 2016.

Continued low fees coupled with commission-free trading are expected to attract even more flows into ETFs rather than mutual funds, but these changes could have other effects as well. ETFs from providers that weren’t included on brokerages’ commission-free ETF platforms may get more notice, says Rosenbluth.

Increasingly, lower ETF fees will magnify the importance of portfolio construction and performance, according to Morningstar’s Johnson.

“Minor differences in seemingly similar funds’ fees are less meaningful … when scaled against the differences in their long-term returns — which can be many multiples larger,” Johnson wrote in a commentary last year. “For example, the four least-expensive ETFs in the large-value Morningstar Category have a fee spread of just 0.01%. But the difference amounted to 1.64% annualized for the five-year period through March 12, 2019.”

ThinkAdvisor.com Senior Writer Bernice Napach can be reached at [email protected].

Bernice Napach

@Think_Napach

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