IndexIQ 2020 ETF outlook: The era of choice and change

by: , Chief Investment Officer and Managing Director | IndexIQ; IndexIQ,

Embarking on a new decade is an opportune moment to reflect not only on the past year, but the past ten years. In this time, ETFs have seen exponential growth and development across many asset classes. It was truly a landmark moment when U.S. equity ETF flows surpassed those of their mutual fund counterparts in August of 2019, according to data from Morningstar. As the industry continues to develop, these are the trends we see as those especially well-positioned to shape the ETF landscape in the years ahead.

Trend #1 – Institutional investors to continue to drive the rise of liquid alternative ETFs

As a provider of alternative ETF strategies since 2006, it was our goal to deliver the diversification benefits of alternatives to all investors. This need became especially apparent after the Financial Crisis of 2008, when unprecedented volatility hit the markets. In that time, a number of players have entered the field and the liquid alternative assets (inclusive of ETFs and mutual funds) have grown from about $170 billion in 2009 to over $340 billion at the end of 2018, according to Morningstar.

According to a survey from Greenwich Associates commissioned by IndexIQ, institutional investors have been increasingly using liquid alternatives since 2015 and their adoption is expected to rise. Many use eight or more strategies to mitigate volatility, deploy uninvested cash, or as a placeholder while conducting a search. Greenwich Associates estimated that institutional allocations to liquid alternative ETFs will rise from $47 billion to $114 billion over the course of the next 12 months. Read the full study here.

Trend #2 – Fixed Income poised to be the next big asset class to challenge the boundaries of active vs passive management

While bonds are considered a safe-haven, interest rates have not rebounded to levels prior to the Financial Crisis of 2008, and yields have continued to be slim. The Fed reverted to a monetary easing in late 2018 fearing that rising rates may slow economic expansion. The 10-year rate has declined from 3.77% to about 1.77% as of December 16th, 2019. Given the reality of low interest rates and the challenge for bond outperformance, investment managers have been looking at innovative ways to find value in fixed income markets.

Traditionally, fixed income ETFs were generally limited to straight index tracking as the bond market was considered too complex and opaque to replicate in an ETF model. Factor-based approaches to fixed income are beginning to attract popularity as two-pronged approach to address the low interest environment and management fees. According to Citywire, in the U.S., overall products within this developing category stand at 50 ETFs, with aggregate assets under management of nearly $8.9 billion as of October 2019.

In addition, best-in-class active managers have begun offering their strategies in an ETF wrapper, providing an opportunity for investors to benefit from not only market expertise but lower fees when compared to mutual funds.

Trend #3: ESG’s transformative impact on investor and corporate behavior to accelerate

After a decade of being the “next big thing”, ESG strategies have begun to attract significant inflows and have moved into the mainstream. Morningstar reported that ESG funds attracted $8.9 billion worth of net inflows during the first six months of 2019, nearly double than the $5.5 billion for all of 2018.This, to us, is just the beginning. As investors are demanding more from their investments; asset managers are rushing to bring more accessible ESG-driven strategies to market that can also provide competitive performance. Proof of concept will determine those firms that emerge as the winners in this fund category, and anyone playing catch-up now is likely already far behind the curve.

Trend #4: The implementation of the ETF Rule to intensify industry competition

After years of explosive growth, the ETF industry is getting lean and mean. According to FactSet Research, through early October, at least 90 funds have closed so far in 2019, after a record 139 closures in 2018. Meanwhile, launches of new exchange-traded products, including ETFs and ETNs, peaked in 2011.

Passage of the SEC’s long-awaited ETF Rule (one of our predictions for 2019) will now provide easier access for new fund providers and new products, something which is likely to kick off a new round of product proliferation. But as these new funds are rolled out, we will undoubtedly see the power of market forces in action. Barriers to entry will be lower, but the barriers to success will only rise. Expect to see fund closures increase in line with launches, and those firms that have a well-defined position in the marketplace to be well positioned for success.

Trend #5: Nontransparent ETFs to usher in a new wave of product development

2019 finally brought regulatory approval for several nontransparent ETF approaches. Now, active managers will be able to bring their strategies to market as an ETF without having to reveal their “secret sauce.” We see this as a very meaningful development for the ETF universe and one that is likely to spur its own wave of product development. We expect that this type of fund will not only grow significantly in number and assets, but also will bring investors into what we’ll call the “era of choice and change” where best-in-class active managers will be making their strategies available via ETF, mutual fund and SMA, allowing investors to choose the vehicle that best meets their need.

Whether it’s 2020 or beyond, there are no shortage of trends to follow across the ETF landscape. We look forward to speaking with all of our clients, colleagues and friends as the new year unfolds.

All investments are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market.

This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

Active management is the use of a human element, such as a single manager, co-managers or a team of managers, to actively manage a fund’s portfolio. Active managers rely on analytical research, forecasts, and their own judgment and experience in making investment decisions on what securities to buy, hold and sell. Actively managed investments typically charge a higher fee that passive or indexed investments.

The data reported in this document reflect solely the views reported to Greenwich Associates by the research participants. Interviewees may be asked about their use of and demand for financial products and services and about investment practices in relevant financial markets. Greenwich Associates compiles the data received, conducts statistical analysis and reviews for presentation purposes in order to produce the final results. Unless otherwise indicated, any opinions or market observations made are strictly our own.

Greenwich Associates is not affiliated with New York Life Insurance Company or any of its subsidiaries.

“New York Life Investments” is both a service mark, and the common trade name, of the investment advisors affiliated with New York Life Insurance Company. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC and serves as the advisor to the IndexIQ ETFs. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Salvatore J. Bruno

Chief Investment Officer and Managing Director | IndexIQ

Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Sal joined IndexIQ in 2007 from Deutsche Asset Management (DeAM) where he held a number of senior positions

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IndexIQ, a New York Life Investments Company, is a trusted provider of innovative financial solutions. IndexIQ ETFs are built and delivered in a way that provides exposures that investors can rely on. A subsidiary of one of the oldest and largest life insurance companies in the world, we have a solid foundation and the resources to continue our culture of innovation…

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