ETFs Grabbing Bigger Share of Investment Pie

Exchange-traded funds continue to beguile the investing world, with global ETF-invested assets sailing past the $4 trillion mark in 2017.

Now comes a new study dissecting why investors favor ETFs. The data from the Boston-based Brown Brothers Harriman & Co. report could shed further light on what influences investors on all decisions.

Not surprisingly, cost of investing is the major factor.

Nearly two-thirds (64 percent) of advisors and institutional investors ranked expense ratio as “very important” when selecting ETFs, ahead of the nine other factors evaluated for importance,” the BBH study found.

Expense ratio ranked second among the most-important factors in past BBH surveys (2014-16) and third in 2013.

In placing expense ratio No. 1 for the first time in the survey’s five-year history, ETF investors ranked it ahead of index methodology, historic performance, tax efficiency and other factors.

“This reflects a continuation of the trend toward low-cost investing that has been underway for some time,” said Shawn McNinch, global head of ETF Services at BBH. “It will be interesting to see how this evolves in 2018 and beyond.”

Price has obviously been a critical issue for investors for decades, but in recent years, as technology reduces the cost of trading, that issue has intensified.

“As always, we learn something when we talk to ETF-focused advisors and institutions,” said Dave Nadig, chief executive officer at ETF.com. “In 2017, we see an increase in focus on costs, which makes sense when you look at both the asset flows, and the growing ETF fee war.”

'Investors are Losing Faith'

But price isn’t the only factor drawing investor into the ETF fold.

“First, investors are losing faith in active investing as witnessed in outflows from active mutual funds,” said Vinay Nair, founder and chairman of 55ip.com, a financial services and technology provider that works closely with investment advisors.

“Second, ETFs have now matured with investors being able to appreciate the attractive features of complete transparency, better liquidity, tax friendliness and lower fees,” he added.

Also, as alpha from active funds has disappointed, investors turned their focus to whether the fees are justified. This mindset became an obsession over fees, Nair said.

“It helps that fees are easily observable and comparable while other aspects may take some analysis/research,” he said. “Costs of lower liquidity or inferior construction are less obvious.”

Investment firms are also seeing a higher awareness and interest in ETFs focused on environmental, social and governance issues, Nadig said.

“Respondents made it clear that they are interested in moving beyond the plain vanilla, into alternatives, international equities, and even actively managed ETFs,” he said. “Look for product launches meeting that need in 2018."

In addition, investors are waiting longer to add new ETFs to their portfolio. Thirty-six percent preferred to wait one-to-three years after launch before adding an ETF, BBH found.

Also, ETF managers are outsourcing portfolio construction and leveraging robo advisors. “For those who outsource their asset allocation, third-party models were the most popular (37 percent) and 17 percent are already leveraging robo advisors,” the report noted.

Report: Advisors on Board

Investment advisors, always cognizant of client wants and needs, are increasingly on board with ETF usage, a separate report found.

New data from Broadridge Financial Solutions, located in Lake Success, N.Y., showed that ETF asset growth is up 19 percent, driven by retail advisory channels.

“Advisors drove significant growth of exchange-traded funds, almost $500 billon, over the last twelve months ending September 30, 2017, with 80 percent of the net new assets
coming from retail channels,” Broadridge reported.

During the third quarter, retail channels captured the majority of net flows with $195 billion, or 77 percent of all ETF net flows.

Additionally, combined net new assets into funds and ETFs from retail channels were up $854 billion versus $353 billion for institutional channels, the report found.

“Advisors continue to embrace ETFs for client portfolio allocations across both equity and fixed-income products,” said Frank Polefrone, senior vice president of Broadridge’s data and analytics business. “The dramatic growth of ETFs is driven by the changing distribution landscape, including the increase in the number of fee-based advisors, as well as the use of model portfolios that primarily utilize ETFs.”

That’s more bad news for traditional active management funds, which are taking it on the chin these days.

“Even though actively managed funds still control most of the industry’s assets, they’re falling farther and farther behind in the race for new money and new clients,” said Jeff Tjornehoj, director of fiduciary and compliance research at Broadridge.

The divide is particularly acute with U.S. equity products, he added, which for most investors is the core of their portfolio.

“Active bond funds -- which have been much less threatened by passive products -- may start to feel the heat if younger investors continue to follow a passive approach as they get closer to retirement,” Tjornehoj said.

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at [email protected].

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