It is ironic that the editor of ETF Stream, who thinks active fund managers cannot predict future stock price performance, has asked me to try to predict what will happen in 2018 in the ETF world. I am not sure why I have been asked as I am the worst stock picker I know and frankly I think he would have been better off asking Mystic Meg, but here goes.
There have been a lot of smart beta products come to the market, but very few smart beta fixed-income products. Here I do not mean duration bucketed ETFs, which I have seen misleading marketed as ‘smart’ but I mean proper, factor fixed-income ETFs based on academic research. For instance, I have not seen any fixed-income ETFs targeting value, momentum or quality strategies, although there has been some very promising academic work in this area. I have started to see some smart beta funds, but nothing yet in the ETF world.
I could argue there is more of a need for smart beta fixed-income ETFs than there is for smart beta equity products. The worst thing that can realistically happen with a market capitalisation equity index is that you buy an overvalued stock. The risks are very different with market cap weighted fixed-income. With market cap fixed-income you invest in the borrower who has borrowed the most and who could be less than creditworthy. This is dumb, as you could be a big investor in the next default (think Venezuela). Surely you want to get away from market cap fixed-income investing, if possible, and to invest on other criteria like value momentum or quality.
There are still one or two areas in the ETF world that strike me as too expensive given their popularity. I wonder if the incumbent ETF issuers are leaving the door open for aggressive new entrants like JPM, L&G or HanETF and maybe others getting their game together like Vanguard. Some of the areas that strike as too expensive might include pretty much the entire bond spectrum including sovereign bonds, emerging market bonds and junk bonds and commodities, especially precious metals.
I am not sure why ETF issuers limit themselves to long only products. Surely a quant-based smart beta value strategy or a momentum strategy will identify good value stocks and bad value stocks; it will identify good momentum stocks and bad momentum stocks. Is it not obvious therefore that we should have long-short smart beta products to take advantage of all these opportunities that are being identified? So far I have seen one European long-short ETF, but I hope this offering widens in 2018.
Trend following or CTAs (commodity trading sdvisors) has been a successful strategy used by hedge funds for years, but it has not yet made its way into the ETF world, with perhaps the noble exception of iFunds’ suite of products. This is odd, as ETFs providers are good at offering commodities, equities and bonds to investors which are the CTA building blocks. Perhaps investors are comfortable with their 2% and 20% hedge funds and distrust new entrants or maybe these high fees will encourage new ETFs.
ETFs are becoming increasingly specialised in what they offer – you can now buy ETFs playing the robotics theme, ageing and at millennials. This is nothing new, during the commodity boom we had shipbuilding ETFs, which sank without trace, and coal mining ETFs, that caved in. It will be interesting to see whether all these ETFs will survive in a Darwinian world and what new ETFs we will see in 2018. It is a no brainer to say we will get more variations on income and ESG/SRI ETFs, and I think I am on pretty safe ground predicting ETFs on the battery/electric car theme although I am sad to say I am not sure we will get any strategies selecting stocks on artificial intelligence, which seems like a shame, given all the hype. These strategies seem destined to remain the exclusive preserve of high fee hedge funds, for now at least.
It strikes me that the logical conclusion of the predictions above is that synthetic ETFs will continue to play a role and may even make a resurgence. If I am anywhere in the ball park with my predictions, these ETFs may need to be delivered through synthetic ETFs. Don’t count on it though, I could not tip a wheel barrow, never mind tip what will happen a year ahead.