Rapid growth in exchange traded fund (ETF) assets last year was bolstered by regulatory change, keen interest from institutional investors and the increasing use of ETFs within multi-asset class strategies, according to FlexShares’ Shundrawn Thomas.
Thomas leads FlexShares ETFs at Northern Trust Asset Management.
ETF assets rose 20 per cent last year and an average of 19 per cent a year over the past 10 years to USD2.55 trillion as of 31 December 2016, according to Morningstar.
FlexShares’ 55 per cent growth in assets in 2016 was the second highest among the 20 largest ETF sponsors in the US.
The ETF industry was buoyed by record flows of USD284 billion in 2016. US equities led inflows with USD168 billion, followed by taxable bonds (a record USD85 billion), and commodities (USD10 billion). Inflows into US equities more than doubled the 2015 total.
“The efficiency and continued innovation of ETFs has really driven demand. They deliver the transparency, cost efficiency, and simplicity that many investors have come to appreciate and value following the 2008 financial crisis,” says Thomas.
One of the most notable consequences of the financial crisis has been regulatory change and uncertainty in the US fund industry. Thomas argues this may accelerate the move toward more efficiently priced products with simple fee structures and even with the potential to pull back on some of those regulations, he believes is favourable for the distribution of ETFs and that the focus on efficiency is here to stay.
“Partly driven by regulation and partly driven by investor preference and demand, we have seen increasing ETF adoption by institutional users such as public funds, foundations, endowments and asset managers,” Thomas says. “In particular, institutions are investing in ETFs to make significant changes in their fixed income portfolios because of liquidity constraints as well as regulatory and market structure changes.”
The trend of more institutional use intersects with the growth of ETFs in multi-asset class solutions. While difficult to track, Morningstar estimates as of 31 December 2016, indicate that ETFs comprise half of portfolio holdings in multi-asset class solutions. With a relentless drive for efficiency, managers of these solutions see ETFs as the preferred vehicle to represent asset classes in their funds.
“There is tremendous interest from investors to find consistent and persistent returns. And it’s even better when those returns can add value at attractive cost. Multi-asset class strategies, especially those that use ETFs, are built to help address that need,” says Bob Browne, chief investment officer at Northern Trust Asset Management. “We use them in our own multi-asset class funds.”
The median expense ratio for US ETF sponsors was 72.8 basis points (bps) at the end of 2016, down from 75.0 bps at the end of 2015. Inflows into broad-based US equity funds helped to drive down the overall average. FlexShares ranks in the lowest decile in terms of the lowest-weighted average price among the 104 US ETF sponsors.
However, the attraction of ETFs is beyond price, Thomas says, noting: “ETFs are popular because they continue to creatively address investor needs.”
Product innovation has come in phases over the years, including equity indexing; the introduction of fixed-income, commodities and real estate products; alternatively weighted indexes and strategic beta; and finally actively managed ETFs.
“The drive toward investment strategies that efficiently capture compensated risk factors and active risk has accounted for much of the interest in alternatively weighted index strategies, the basis for many of our products,” Thomas says. “We try to build products around the way investors think. Investors have clear objectives. We develop investment strategies tailored to meet those objectives.”