As this year's Inside ETFs programming made clear, innovation in financial services tends to benefit the investor. From developments in responsible investing to significant growth in fixed income, investors have more opportunities to fine-tune their portfolios than ever before.
The Price War Continues
The battle of low-to-no fees shows little sign of abating. On Monday, Schwab announced that it was nearly doubling the number of commission-free ETFs on its OneSource platform, from 257 to 503 ETFs available to investors. Within hours, Fidelity announced that it, too, was increasing the number of commission-free ETFs available through its platform, from 265 to more than 500.
The moves make sense. Investors show a strong preference for lower priced funds.
According to Morningstar, in 2017, the cheapest 20% of all funds saw net inflows of $949 billion. The remaining, more expensive 80% of funds, saw net outflows of $251 billion.
This price pressure has driven down prices across the board. Thankfully, the real winner is the end investor, who today pays significantly lower fees for products that may have been inaccessible just a decade ago.
BlackRock, whose iShares ETFs comprise a significant portion of the commission-free funds, addressed this benefit. “The reduction and elimination of historic barriers to investing enables more people to save, invest and reach their long-term financial objectives using iShares ETFs as key building blocks for their investment portfolios,” a BlackRock spokesperson said in a release coinciding with Schwab's.
Responsible Investing Finds its Momentum
Socially responsible investing has continued to grow the early favor it originally found with exclusionary-minded investors, and is becoming a serious contender for managers and clients chasing compliance and conscience-friendly returns. According to USSIF, 26% of all U.S. domiciled assets are now managed according to socially responsible investing criteria.
Headlining Monday evening's session was Paul Tudor Jones, co-founder of JUST Capital which manages the index that underpins the Goldman Sachs JUST U.S. Large Cap Equity ETF. Jones' firm measures and ranks companies based on corporate behavior and public opinion, including the companies' ability to reflect and address issues of national concern.
The ETF is constructed around Jones' belief that capitalism in its current form is unsustainable, with wealth inequality to blame:
"Eighty-two percent of wealth last year went to the top 1%."
Investors may find the reason for this inequality particularly frustrating. Jones said that a large portion of our current wealth inequality is the result of companies focusing solely on delivering value to their shareholders.
That mantra may play well in board meetings, but companies often hold on to cash or buy back shares, helping the wealthiest entities get even richer, rather than investing in their employees or communities. The solution, Jones believes, is to "...use capitalism itself" to redefine what it means to be a stakeholder in a company, so that other groups, such as workers, also reap the benefits of buying in.
Jones' strategy belies a broader shift in the responsible investing space. While early ESG strategies were simply exclusionary, managers are finding new ways to harness the customization offered by ESG, adjusting indexes to investors' hyper-specific preferences and motivations.
The resulting strategies have clearer goals, which are easier for investors to understand, and for managers to quantify, compared to the earlier days of ESG screening. "You can use a standard ESG overlay and you'll get an improvement in ESG score, but you won't necessarily get a reduction in carbon," says Martin Kremenstein, head of retirement products and exchange-traded funds at Nuveen.
In the past, exclusionary investing strategies would typically remove a significant portion energy or utility stocks from a traditional benchmark. This would skew the portfolio away from the benchmark sector exposures and result in a "growth portfolio," says Kremenstein.
Nuveen's current strategies seek to reduce a portfolio's carbon footprint while maintaining close-to-benchmark sector exposures. "We want to have full-sector coverage," says Kremenstein.
"Ultimately, the long term goal [for Nuveen] is, wherever you see assets in a non-ESG ETF, you should see an ESG version of it from us."
Fixed Income ETFs Come of Age
One of the primary concerns that investors have regarding fixed income ETFs centers on liquidity. While ETFs are highly liquid, or easily tradable on equity exchanges, the underlying securities are more thinly traded. When markets are volatile, this could theoretically lead to dramatic swings in price.
According to Kremenstein, and echoed throughout the conference, these fears are overblown. "You don't magically create liquidity in the fixed income market by creating an ETF," he says.
In fact, during the two dramatic swings in high yield bond prices in the past two years, "High yield ETFs performed really well."
Finding the Right Benchmark
Chatter over the Bloomberg Barclays US Aggregate Bond Index (the "Agg") dominated discussions of fixed income at Inside ETFs this year. During a panel on bond ETFs, Jason Singer, head of fixed-income ETFs at Goldman Sachs Asset Management, suggested the Agg is a "blunt instrument" that gives investors broad fixed income exposure.
Since the Fed's quantitative easing has led to the issuance of more U.S. Treasuries, the securities now comprise more than 40% of the benchmark, lengthening the average duration and leaving it less diversified across sectors.
According to Jayni Kosoff, managing director and head of fixed income ETFs at FTSE Russell, since the financial crisis, investors have been forced to reflect on the role that fixed income plays in their portfolios. According to Kosoff, investors are now asking whether their "broad market fixed income benchmark is going to do the job moving forward."
The trend, Kosoff says, is that asset holders now have to interrogate their bond exposure. The trend in fixed income is asset owners saying "we need to be more thoughtful about fixed income exposure" and "break it down into the individual fixed income asset classes" and within each, "and look for risk-adjusted performance."
While fixed-income ETFs haven't garnered as much attention as their equity counterparts, U.S. fixed income ETFs attracted nearly $90 billion in assets in 2018.
In the End, Investors Win
Changes in the ETF market reflect a fundamental shift across the industry. Product innovation and falling fees have given investors more resources than ever, allowing them to personally construct their own portfolio, tailored to their desired levels of diversification, all with just a few, low-cost ETFs.
The result is that as investors can do more on their own, financial professionals are forced to adapt. "As asset allocation becomes more commoditized and less valued, the financial advisor is going to [...] concentrate on where they add value, which is financial planning," says Kremenstein.