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ETFs To Hit $5 Trillion In Assets By 2020: PwC

By Clayton Browne A new report from PwC highlights the ETF industry continues to mature Exchange Traded Funds (ETFs) have been only been around for two decades, but they have grown far beyond their initial function of tracking large indices in developed markets and have become an investment sector of their own. As of year-end 2014, ETFs now hold over $2.6 trillion of assets globally and continue to grow rapidly. In fact, PwC projects that the ETF space will top $5 trillion in assets by 2020. Tax and and audit consultancy firm PwC recently published a report titled “ETF 2020: Preparing for a new horizon”. The report is based on a survey of 60 financial industry firms including ETF managers , asset managers and service providers. Increasing segmentation in ETF sector The PwC report points to the increasing segmentation of the ETF market. Institutions are committing more assets as more and more firms find uses for them. Also of note: “The advisor market continues to evolve quickly, with ETF strategists playing a growing role in the U.S. market and now emerging in Europe . Segment and channel trends are largely driven by local considerations, so regional differences abound.” (click to enlarge) While the growth of ETFs has slowed in the U.S. in the last few years, the industry is still expanding in other regions (such as Europe and Asia). According to the PwC report non-traditional indexing is becoming more important in many markets, “while active ETFs are on the verge of radically changing the AM [asset management] industry in the U.S.” Non-transparent active ETFs potential growth area (click to enlarge) In a setback for the industry, two firms seeking approval from the SEC to launch non-transparent active ETFs, which would offer less than the current daily transparency of the portfolio holdings using a blind trust, were denied late last year. However, the sector did get some good news when SEC approved the request of another firm to launch a different type of non-transparent active investment product referred to as exchange-traded managed funds in November last year. The report notes that this new innovation has caught the eye of current and prospective ETF sponsors. The authors anticipate that firms will continue to seek approval to set up non-transparent active ETFs, and argue this “could provide another phase of growth and innovation in the coming years.” Issues facing industry PwC acknowledges that the ETF industry will face numerous challenges in the coming years. One potential issue is changing demographics forcing asset managers to design solutions suitable for a rapidly aging population. Technology is also likely to radically alter the way investment advice and products are evaluated and consumed, and ETF firms must be ready to evolve. The report also notes that regulatory constraints and distribution dynamics benefiting other investments may reduce growth in some markets. The increasingly saturated U.S. marketplace is also a major concern. Disclosure: None. Share this article with a colleague

Inside The New Target Factor ETFs From iShares

Deflationary fear and a slowdown have started to trouble developed international markets, and most investors in the ETF world are looking out for quality exposure in the area. In fact, some aggressive investors are hunting for high momentum stocks presuming that these might outperform in the days ahead in the prevailing easy money era. Their search looks justified. After all, the Fed withdrew its gigantic QE program last year and might start walking the way of policy tightening later this year. Thanks to such policy differential in the developed world, iShares – the largest ETF issuer in the world – brought about two products targeting the developed international economies probably to quench investors’ thirst. We have detailed the two newly launched funds below. iShares MSCI International Developed Momentum Factor ETF ( IMTM) : For a broad foreign market play with a focus on large-and-mid cap companies, investors could consider IMTM which focuses on 12 developed countries for exposure. Stocks that exhibit a higher price momentum will be included in the fund. This product follows the MSCI World ex USA Momentum Index, holding 269 securities in its basket and charging a pretty low fee of 30 basis points a year for this relatively unique exposure. Though the fund holds about 28% exposure in the defensive health care sector, it is more inclined toward higher beta sectors like financials, industrials companies and consumer discretionary. Top nations include Japan (29.6%), Canada (18.0%), and Switzerland (12.9%) while the U.K. (8.8%) and Germany (4.7%) round out the top five for this well-diversified fund. The fund does not have much company concentration risk with no stock accounting for more than 5.34% of the fund. Novartis (NYSE: NVS ), Roche and Bayer ( OTCPK:BAYRY ) are the top-three holdings of the fund. IMTM Competition: Momentum strategy is not yet popular in the ETF world. Though the domestic economy has a couple of ETFs including the $1.46 billion-First Trust Dorsey Wright Focus 5 ETF (NASDAQ: FV ), $1.61 billion-PowerShares DWA Momentum Portfolio (NYSEARCA: PDP ) and $515 million-iShares MSCI USA Momentum Factor ETF (NYSEARCA: MTUM ), the international arena is relatively less penetrated. Global Momentum ETF (NYSEARCA: GMOM ) made an entry late last year in the international space and has amassed about $26 million in assets so far. Given GMOM’s high expense ratio of 94 bps and iShares’ own product MTUM’s considerable success in a short span, we expect the issuer to replicate the success on its global version as well. However, the issuer should take note of Cambria’s active approach to the momentum theme which might give it an edge over IMTM in volatile markets. iShares MSCI International Developed Quality Factor ETF ( IQLT) : This fund gives investors exposure to quality stocks (excluding U.S.) by identifying companies that have the highest quality scores based on three main fundamental variables – high return on equity, stable earnings year-over-year growth and low financial leverage. The product charges investors 30 basis points a year in fees and tracks the MSCI World ex USA Sector Neutral Quality Index. The fund holds about 289 securities in its basket with a focus on financials (26.9%). Industrials (12.1%), Consumer Discretionary (11.5%), Health Care (10.8%) and Consumer Staples (10.6%) occupy the next four spots. The fund is heavy on the U.K. with about one-fourth of the exposure followed by Switzerland (15.6%). Roche takes the top-most allocation in the portfolio with about 5.2% exposure followed by Novo Nordisk (2.7%) and Nestle (2.31%). IQLT Competition: There are currently a few products operating in the space including PowerShares S&P International Developed High Quality Portfolio (NYSEARCA: IDHQ ), SPDR MSCI World Quality Mix ETF (NYSEARCA: QWLD ) and Market Vectors MSCI International Quality ETF (NYSEARCA: QXUS ). While neither has developed a huge following so far and IDHQ charges a bit high at 55 bps, IQLT has scope for outperformance.

A Revelation For Small-Cap Investing Strategies

Suddenly, business as usual for small-cap investing is in need of a makeover, thanks to a new research paper (a landmark study for asset pricing) that revisits, reinterprets and ultimately revives the case for owning these shares – after controlling for quality, i.e., “junk”. Cliff Asness of AQR Capital Management and several co-authors have dissected the small-cap effect anew and discovered that there is a statistically robust small-cap premium across time after all, but only for companies that aren’t wallowing in financial trouble of one kind or another. The paper’s title says it all: ” Size Matters, If You Control Your Junk .” At the very least, the study will reframe the way the investment community thinks about small-cap investing, perhaps leading to a new generation of ETFs in this space with freshly devised benchmarks. Does that mean that the enigma of the small-cap premium has been solved? Let’s put it this way: suddenly, the topic looks a lot less cryptic. For those who haven’t been keeping up-to-date on the strange case of the on-again, off-again small-cap premium, a growing pool of research has raised doubts about this risk factor. Although there was much rejoicing in the years following the influential 1981 paper by Rolf Banz ( “The Relationship between Return and Market Value of Common Stocks” ) – the study that effectively launched the industry of small-cap investing – the pricing anomaly has fallen on hard times in recent years. As Asness et al. advise: Considering a long sample of U.S. stocks and a broad sample of global stocks, we confirm the common criticisms of the standard size factor: a weak historical record in the U.S. and even weaker record internationally makes the size effect marginally significant at best, long periods of poor performance, concentration in extreme, difficult to invest in microcap stocks, concentration of returns in January, absent for measures of size that do not rely on market prices, and subsumed by proxies for illiquidity. This is old news, of course. What’s new is the finding that “controlling for quality/junk reconciles many of the empirical irregularities associated with the size premium that have been documented in the literature and resurrects a larger and more robust size effect in the data.” In other words, the small-cap factor is alive and kicking, but it requires some tweaking in how we think about this slice of equities, namely, by focusing on comparatively “high-quality” firms. In summary, controlling for junk produces a robust size premium that is present in all time periods, with no reliably detectable differences across time from July 1957 to December 2012, in all months of the year, across all industries, across nearly two dozen international equity markets, and across five different measures of size not based on market prices. The critical issue is that small-caps generally are populated with a relatively high share of “junky” firms. Whereas large firms tend to be of higher quality – defined by, say, profits or earnings stability – there’s a wider spectrum of dodgy operations among smaller firms. That’s not surprising, but it does have major implications for how we think about expected return in this corner of the equity market. It’s puzzling that no one’s documented this previously, at least not as thoroughly and convincingly as Asness and company have. In any case, the results speak loud and clear: if you’re intent on carving out a dedicated allocation to the small-cap factor, you’re well advised to do so by focusing on relatively high-quality firms in this realm of the capitalization spectrum. Keep in mind, too, that the findings don’t conflict with the value factor, although here too there may be a bit more clarity in the wake of the paper. In fact, the authors “find that accounting for junk explains why small growth stocks underperform and small value stocks outperform the Fama and French (1993, 2014) models.” Ultimately, the numbers speak volumes. The new paper slices and dices the data from several perspectives, and it’s worth the time to read through the details to understand how this study revises our understanding of small-cap investing. “Overall, there is a weak size effect, whose variation over time and across seasons is substantial, as documented in the literature,” the researchers write. The smoking gun is that the case for small-caps looks much stronger when sidestepping the junkiest firms. A graph from the paper summarizes the point. Indeed, the difference between the cumulative investment return for the conventional definition of small-cap (SMB, or small minus big) vs. the proxy defined by Asness et al. (SMB-Hedged) is quite stark over the past half century. (click to enlarge) The paper’s discovery amounts to an important revelation for asset pricing, and arguably something more substantial for investors who toil in the small-cap waters. In short, it seems that small-cap strategies, as currently designed, are in need of revising, perhaps dramatically so, depending on the portfolio, ETF or mutual fund. Yes, Virginia, there is a small-cap premium, but to harvest it in a meaningful way, we’ll have to rethink how we invest in these companies.