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ETF Trends For 2016: Part 3, Management Fees

In part 1 of this series, we reviewed the growth of the ETF market in 2015 and introduced the series by covering currency-hedged products. In part 2 , we took a look at robo-advisors, a well-covered topic that could have a huge impact on the way ETFs are utilized. In this final piece in the ETF Trends series, we will cover management fees and the competition it causes between issuers, and a conclusion on the potential for the ETF Industry in 2016. The ETF Fee War While some issuers are creating funds for specific market niches, other issuers are taking a different approach when looking to stand out in the sea of possible funds, as articulated by Crystal Kim for Barron’s : Early this November, BlackRock (NYSE: BLK ), the largest exchange-traded fund provider by assets, trimmed fees by two to three basis points (two to three one-hundredths of a percent) on seven iShares Core ETFs. The expense ratio of the iShares Core S&P Total U.S. Stock Market (NYSEARCA: ITOT ) was taken down to 0.03%, winning the crown for cheapest ETF on the market-briefly. That is, until Schwab (NYSE: SCHW ) matched it by lowering fees by one basis point on four large-cap ETFs. The Schwab U.S. Large Cap fund (NYSEARCA: SCHX ) now stands toe-to-toe with its counterpart at iShares, fee-wise. For every $10,000 invested, the rival funds cost a mere $3. That’s cheaper than a copy of Barron’s at the newsstand. There are pieces covering the ETF price war going back to 2010, so this is by no means a new discussion topic for ETF investors. However, price wars continue to play a role in the ETF investment scene as a way to attract retail investors. The Trefis Team lays this relationship out for us: The largest avenue of growth for ETF providers over the coming years is expected to be the retail investor market, which remains extremely under-served. As retail investors are much more sensitive to expense ratios, asset managers have been trying to attract them with a string of low-cost ETFs. The following image is another from the ICI 2015 Investment Company Fact Book, showing the growth in ETF AUM by retail investors. Assets in ETFs accounted for about 11% of total net assets managed by investment companies at year-end 2014 and net issuance of ETF shares reached a record $241 billion. Click to enlarge While there are a number of funds digging deep to keep costs low in an effort to attach larger clients, the average ETF expense ratio is still 0.44%. This is mainly due to the number of active and narrow-focused funds that can still afford to charge investors more, because they are the only ones currently available in the space. But as market saturation continues, being the only player may not be a given. This is great news for investors interested in these niche offerings but aren’t willing to foot the bill at this time. For reference, the average mutual fund expense ratio is 0.70% (down from 0.90% in 2000 before ETF competition started to take hold), so it is no small feat that ETFs are as cost effective as they are today. But as issuers continue to fight for retail investors in the coming year, we should expect to continue to see expense ratios slashed. This slashing is not just good news for institutions, but the individual issuers who get to enjoy cheaper management fees as well. Concluding Thoughts For 2016: ETFs Continue To Grow When asked about the ETF industry in early 2015, Amy Belew, Global Head of ETP Research at BlackRock stated : The global ETP (Exchange-Traded Product) industry continues to grow at a double digit pace as ETPs attract a broader base of global investors than ever before. ETPs are being used by capital market participants looking for deep liquidity, to investors seeking precision exposures, to a growing segment of the market using ETFs as buy and hold investment vehicles. We are forecasting global ETP assets to double to $6 trillion over the next five years. While future trends within the ETF industry are impossible to perfectly predict, I believe this an industry that will only continue to evolve and grow to meet investors’ needs in 2016.

Our Growing World

Photo Credit: Ejaz Asi In general, I tend not to go in for macro themes. Why? I tend to get them wrong, and I think most investors also get them wrong, or at least, don’t get them right consistently. I do have one macro theme, and it has served me well for a long time, though not over the past two years. I was using the theme as early as 2000, but finally articulated it in 2006. At that time, I was running my equity strategy for my employer, as well as in my personal account. They used it for their profit sharing plan and endowment. They liked it because it was different from what the firm did to make money, which was mostly off of financial companies, both public and private. They didn’t want employees to worry that their accrued profit sharing bonuses would be in jeopardy if the firm’s ordinary businesses got into trouble. In general, a good idea. At the end of the year, I needed to give a presentation to all of the employees on how I had been managing their money. Because my strategies had been working well, it would be an easy presentation to make… but as I looked at the prior year presentation, I felt that I needed to say more. It was at that moment that the macro theme that I had been working with became clear to me, and I called it: Our Growing World. The idea is this: in a post-Cold War world where most economies have accepted the basic idea of Capitalism to varying degrees, there should be growth, and that growth should create a growing middle class globally. This middle class would be less well-off than what we presently see in America and Western Europe, at least initially, but would manifest itself in a lot of demand for food, energy, and a variety of commodities and machinery as the middle class grew. Now, I never committed everything to this theme, ever. Maybe one-third of the portfolio was influenced by it, on average. Most of what I do was and still is more influenced by my industry models, and by bottom-up stock-picking. That said, the theme has a cyclical bias, and cyclicals have been kicked lately. I still think the theme is valid, but will have to wait for overinvestment and overproduction in certain industries to get rationalized globally. Were this only a US problem, it might be easier to deal with because we’re far more willing to let things fail, and let the bankruptcy process sort these matters out. Governments in the rest of the world tend to interfere more, particularly if it is to protect a company that is a “national champion.” But the rationalization will take place, and so until then in cyclical industries I try to own financially strong companies that are cheap. They will survive until the cycle turns, and make good money after that. That said, the billion dollar question remains – when will the cycle turn? More next time, when I write about my industry model. Disclosure: None

Comparing Portfolio Performance (1973 To 2015)

I’ve finally managed to gather enough portfolio performance data to put together this year’s portfolio comparison edition. I was able to add 2014 and 2015 data. Last year’s post is here . You can use last year’s post and the Portfolios page for portfolio definitions. I’ll present the comparison of the portfolios in a few ways. I also added a few new fields this year. I added the last 3-yr, 5-yr, and 10-yr performance for each portfolio and performance in the last bull market and last bull/bear market cycle. Now, on to the data. First, let’s present the data in its most traditional way, by sorting the portfolios in terms of performance over the full time period, 1973 through 2015. There is a lot of data in these images so click on the image to make it easier to see. Click to enlarge A few notes on this presentation. Performance, CAGR, is highlighted in light orange. The most common, ‘traditional’ benchmarks, are highlighted in light blue. The portfolios in yellow are some of the popular buy and hold allocations where I had to create or simulate the last 2 years of performance data based on their allocations. This method is pretty accurate since they’re passive portfolios but still the data is not exact and does not come from a standard source. So, what’s the main message here? Quant and TAA portfolios provide the highest performance over the entire time period. The Bernstein portfolio is the highest ranked buy and hold portfolio on the list at #12. Now on to risk-adjusted performance. Risk-adjusted performance is a much better metric in choosing portfolios. Here I present the portfolios sorted by the Sortino ratio, which doesn’t penalize portfolios for upside volatility, instead of the more traditional Sharpe ratio. Click to enlarge In risk-adjusted terms, quant and TAA portfolios are also at the top of the list. The highest ranked buy and hold portfolio is the Risk Parity portfolio at #9. Risk-adjusted metrics like the Sortino ratio are particularly important for investors in the withdrawal stage of their life. Higher risk-adjusted returns is highly correlated with higher SWRs in retirement. Great, but many investors ask, ‘what have you done for me lately’? Maybe markets have changed, maybe what worked in the past doesn’t work anymore, etc… Many investors use recent performance, especially since the start of the most recent bull market in 2009 to make portfolio comparisons. This is a mistake. You should at least look at the most recent bull/bear market cycle in addition to the full history. Below are the portfolios sorted by performance since the start of the last, in this case, the bear/bull cycle, which started in 2007. Click to enlarge Nothing surprising or new here. Quant and TAA portfolios have led the pack in the last full market cycle. The highest performing buy and hold portfolio, the 70/30 US stock bind portfolio, comes in at #9 with the vast outperformance of US markets over pretty much anything else in that time. There you go. Tons of data to make all kinds of comparisons. Go crazy. These are my favorite 3 ways to look at portfolio performance.