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By Sandra Testani - March 12, 2019
By most accounts, 2018 was a challenging year for investors. Yet, with $312 billion in flows last year, exchange-traded funds (ETFs) experienced their second largest year of flows behind 20171. What's particularly impressive about these figures is that nearly one-third of 2018 flows came during the fourth quarter—during the same time period the S&P 500® Index declined by more than 13%.
What's to come in 2019? That is, to be sure, the million-dollar question. But considering the biggest months of the year for ETF flows have been January, February, November and December, it's too early to say. One thing we do know is that investor interest continues to grow—as evidenced by the roughly 2,300 that joined several colleagues and me at last month's Inside ETFs conference .
In our second trip to the event, I walked away with three big takeaways:
Much of the conference reinforced that ETFs are seen by many as innovative, disruptive and delivering on their core value proposition for investors. Some of the most interesting data points and impressions I noted include:
Many investors equate ETFs with passive investing. They may be surprised to learn that active within ETFs is one of the higher-growth segments, with the majority of active assets being held in fixed income. There's an almost consensus view within fixed income that markets are so inefficient that indices leave opportunities and risks on the table.
Passive fixed income indices don't take a view on a company's ability to pay—and whether you think we're in the fifth or tenth inning of this credit cycle, understanding what you own and whether you are being compensated for the potential risk you're taking should matter. These indexes may also rely heavily on the investment grades issued by rating agencies to determine the quality of the underlying securities. While credit agencies have a place and role in ETF decisions, they're not the be-all and end-all for decisions on a company's attractiveness. There can be a wide range of company quality within each grade.
Active managers can help narrow the range by creating their own proprietary models to further screen for quality beyond the initial rating and by employing fundamental analysis. At American Century, we use a proprietary system to evaluate company fundamentals and independently grade every security we invest in. We simply use rating agencies to bucket companies into investment grade and high-yield.
If active investing was the focus within fixed income, factor investing led the commentary within equities. Factors are, simply put, characteristics that influence an investment and drive return. Some of the most common factors are value, size, momentum and quality. There doesn't appear to be confusion around the concepts with the advisors but end investors do find it somewhat unclear considering the seemingly endless ability to combine factors.
For advisors, the pain point is in implementation—and the inability to check factor exposure.
Head of ETFs Edward Rosenberg joined a panel presentation at Inside ETFs, "Figuring Out Factors: Strategies for Implementation." Audience members hoping for clarification were likely left surprised at how different the approach and views on factors were, even among this small subset of practitioners. While factor-based investing, according to Edward, is a viable long-term approach for portfolio construction, it doesn't alleviate the need to understand the individual strategy, how it's constructed and its objectives to ensure it is well-suited to meet individual objectives.
With factors, active money managers still play a critical role—actively making decisions to ensure the correct level of exposure. There is a place for both active and passive in most investment portfolios. Be thoughtful how you use them.
The conference reinforced that ETFs are the wave of the future. The structure is still early in its lifecycle, but clearly growing faster than other parts of the financial industry. There are still innovations to be made and, as the products get more complex, it is more important than ever for advisors and clients to really understand both what a product is trying to accomplish and how it works.
1 Strategic Insight Simfund, as of 12/31/2018.
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March 12, 2019
2020 may well be the year that marks a true inflection point for exchange-traded funds (ETFs).
Diversification does not assure a profit nor does it protect against loss of principal.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Exchange Traded Funds (ETFs) are bought and sold through exchange trading at market price (not NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions will reduce returns.