The increased adoption of ETFs was one of the most striking of all the investment revolutions that characterized the 2010s. A decade ago, many retail investors still considered ETFs to be novel, exotic, and somewhat complicated. And institutions weren’t rushing to embrace ETFs either, as many were already reaping low cost benefits from other index vehicles.
We’ve come a long way. Retail and institutional investors alike have grown comfortable with ETFs and their potential benefits. With a decade of widespread ETF growth in the rearview, we’re looking ahead to what could be in store for ETFs in the 2020s.
1. Alt-ETFs 2.0
ETFs were initially plain vanilla—offering exposure to broad, familiar asset classes—but ETF innovation over the past several years has been substantial. We expect this innovation to continue into the 2020s, particularly with respect to alternative exposures. Over the next decade, lookout for more ETFs tracking private equity, merger arbitrage, and digital assets indexes. We also wouldn’t rule out ETFs that track preference shares indexes, which are designed to straddle equity and fixed income asset classes.
2. ETFs for yield-starved appetites
Fixed income yields have held steady at depressed—or even negative—levels for a long stretch, and there’s little indication this trend won’t extend into the 2020s. The hunt for yield often leads investors into the riskier corners of the bond market, such as fragile countries, heavily indebted companies and opaque, financially engineered instruments.
This can present an opportunity for both index and ETF providers. While yield scarcity might lead some investors to seek fixed income products where the risks aren’t visible or fully understood, ETFs can offer a simpler, more transparent solution. Index providers are tasked with effectively shedding light on higher yielding fixed income markets and providing measurable, accurate performance data. And ETF providers can offer funds that track these indexes to meet continued investor demand for yield without the opacity of other instruments.
3. Smart Beta and factors thrive
We expect several of the ETF trends that took root in the 2010s to continue to gain in both momentum and size in the coming decade. Broadly, we expect continued growth in overall ETF AUM. The adoption of smart beta or factor strategies will keep rising. In July 2019, FTSE Russell’s sixth annual smart beta survey found that 58% of institutional investors surveyed had implemented smart beta strategies, up 10% from 2018. Multi-factor strategy usage proved most popular, increasing to 71% globally in 2019, up 22%. Adoption of these strategies increased to 60%, in North America, up 18% from 2018 to 2019. And more than 77% of European respondents expressed interest in applying ESG considerations into smart beta allocation—up 22% from 2018.
4. ETFs become asset allocation bedrock
Many investors who were unfamiliar with ETFs ten years ago now use them as core building blocks for retail portfolios. In fact, ETF managed portfolios—those that have more than 50% of assets invested in ETFs—have been one of the fastest-growing segments of the managed account universe, representing over $120 billion in assets. We expect to see continued growth in this area, as more and more advisors consider ETFs the go-to vehicle for core asset allocation.
As retail investor adoption of ETFs has grown, so too has institutional ETF usage—in fact, in a recent survey, 78% of institutions cited ETFs as their preferred vehicle for index strategies. Most institutional investors are turning to ETFs for their exchange-traded flexibility, which makes them useful vehicles for tactical allocations. For example, in early 2019 many investors had spent the prior 12 months shortening the duration of their portfolios, only to seek duration lengthening trades following the Federal Reserve’s pivot to a more neutral stance. ETF flows data indicated that a large number of investors used ETFs to nimbly manage their fixed income exposures in reaction to the news, and indeed that ETFs flows into fixed income ETFs were on an upward trajectory during the decade.
Source: FTSE Russell/XTF. As at December 31, 2019. Past performance is no guarantee of future performance.
We would expect "ETF managed portfolios" to keep becoming more popular. These solutions typically use ETFs as building blocks for more of 50% of their invested assets that are then packaged into various investment strategies. As Morningstar noted in its ETF Managed Portfolios Landscape Report, these portfolios represent one of the fastest-growing segments of the managed-account universe. Benchmarking (often blended benchmarks) still has an important role to play in this area of the market.
 Morningstar, Morningstar ETF Portfolios Landscape Report, Q1 2018
 Greenwich Associates, ETFs: U.S. Institutions’ New Tool of Choice for Portfolio Construction, Q1 2019
 Morningstar, Morningstar ETF Managed Portfolios Landscape Report, Q1 2018
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