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The outlook for ETFs in 2017

Nicki Bourlioufas  |  13 Dec 2016Text size  Decrease  Increase  |  

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The Australian exchange-traded funds (ETF) market experienced good growth in 2016, with products getting more sophisticated. Experts expect the market will reach a market capitalisation of over $30 billion in 2017.

As at the end of October 2016, there were 150 exchange-traded products (ETPs) listed on the Australian Securities Exchange, up from 128 a year earlier. The market had a capitalisation of $23.95 billion, up 16 per cent from October 2015, according to the ASX Funds 2016 Monthly Update.

A big chunk of ETPs traded were focused on Australian equity, accounting for around 47 per cent of the value traded by asset class in October 2016, though global equity ETPs made up 26 per cent.

Australian fixed-income ETPs accounted for another 16 per cent of the value traded by asset class in October 2016, but accounted for 24 per cent of total ETP flows in October, as they gain popularity in volatile markets.

According to the head of strategy and marketing with BetaShares, Ilan Israelstam, 2016 has been a big year for product development, with 40 new ETPs launched over the year to 31 October 2016.
"We expect 2017 to continue in the same way, with significant product development. We expect more new products in the smart beta area, meaning products that are not weighted based on the market capitalisation of their constituents, as more and more investors and advisers see the potential for these products to offer active-like returns for index-like costs," he says.

Israelstam predicts an ETF industry size of between $30 billion to $33 billion by the end of 2017.

Arian Neiron, managing director, VanEck Australia, expects to see investors accessing sectors and investment strategies to improve the robustness of their portfolios.

"For example, investors are increasingly investing in the small-caps sector and resources sector using ETPs. The search for income has been a dominant theme in ETP investing this year and will likely continue in 2017," he says.

"Fixed-income investors started shifting out of long-term bonds to short-term bonds in anticipation of rising interest rates. Sector dispersion will also continue as investors access sectors like infrastructure as a result of Trump's proposed $1-trillion infrastructure plan."

BetaShares' Israelstam says dissatisfaction with active fund managers has added to flows into ETFs, including into fixed-income products, as reflected in relatively large flows into the sector in October.

"Driving this, in particular, is an increased focus on costs versus performance. The performance of a large number of active managers in fixed income has been poor relative to benchmark--with approximately 90 per cent of Australian active fixed-income managers underperforming an index benchmark in the five years to 30 June 2016, according to recent research by S&P Dow Jones. With such results, it's no wonder that more and more investors are considering investing in low-cost ETF products focused on fixed income," he says.

Neiron takes up this point and says the latest S&P Dow Jones SPIVA Scorecard to the end of June 2016 found the majority of active fund managers in Australia unperformed their respective benchmarks over one, three and five years.
"Not surprisingly, investing in smart-beta ETFs has risen while active performance has declined. Given this trend, it could be likely that some active managers who have quantitative divisions will launch smart-beta indices that leverage their investment philosophies and processes," he says.

"We expect smart-beta ETF investing will continue to disrupt the active management industry in 2017 as performance continues to suffer and factors such as uncompetitive fees become an issue for investors."

Smart-beta ETFs are a form of investment that blends passive and active investment styles. Rather than simply weighting stocks by market captalisation, as traditional ETFs do, smart-beta ETFs are based on indices which are specifically constructed to meet an investment objective or strategy, often taking into account factors such as the size of a company, its value and volatility.
More active exchange-traded managed funds (ETMFs) are also expected to arrive on the market.

"We believe the active ETMF part of the market may well be the most exciting and fastest growing area of all--with traditional active managers likely to develop their own exchange-traded offering or partner with existing ETF issuers," says BetaShares' Israelstam.

Neiron also expects to see more risk mitigation strategies in 2017 as market volatility remains. He says the global economy remains weak and is in no condition to withstand higher policy rates; this could benefit the gold price and gold ETFs.

"A December US Federal Reserve rate hike could work against gold initially, but over the longer term, it is likely to be seen as a misstep that could increase financial stress. Uncertainty around Trump's foreign and domestic policies is also likely to support the price of gold in 2017."

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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

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