“Most investors will not miss any of these funds,” Rosenbluth added.

Expenses Getting Smaller, Smaller, Smaller
Intense price competition is expected among broadly diversified index products. In September, Schwab cut expense ratios on all 15 of its diversified ETFs, and iShares followed suit in October with expense ratio cuts on six of its core ETFs, including iShares Core S&P 500 Index (IVV).

ETF providers are looking to lure new investors into their products and are betting that cheap, broadly diversified funds will prove attractive. Rosenbluth expects pressure on expense ratios to continue in 2013, as more assets move into these products and providers pass along the benefits of increasing scale. 

ETFs will continue to gather assets in 2013 despite all the uncertainty about fiscal policy and the state of the U.S. economy, according to S&P. Areas of growth will include dividend-themed ETFs even though taxes on dividends will probably rise, Rosenbluth said.

Despite talk of higher taxes, dividend focused sectors such as utilities and consumer staples have continued to perform well in recent weeks. “Investors still want yield,” Rosenbluth said, adding that funds that do not focus solely on yield but on companies that consistently raise their dividends––such as Vanguard Dividend Appreciation (VIG)––are particularly attractive.

Beyond The U.S.
Rosenbluth also expects diversified international and emerging market ETFs to attract assets in 2013, as uncertainty over the fiscal cliff subsides and investor risk tolerance returns. While the consensus among analysts is for strong growth in emerging markets including China, Russia, Mexico and Turkey, Rosenbluth recommends investors focus on funds that are broadly diversified such as the iShares Core MSCI Emerging Markets ETF (IEMG) and Vanguard Emerging Markets Index (VWO), even though the latter’s benchmark is changing and there will be changes in portfolio holdings.

Active Fixed Income
On the heels of Pimco’s highly successful launch of BOND, S&P also expects to see more actively managed fixed income ETFs. Legg Mason recently got SEC approval to launch an actively managed, ultra-short duration bond ETF, while Fidelity recently filed to offer an investment grade corporate bond ETF.

Investors have shown a willingness to pay slightly higher expense ratios for actively managed fixed income ETFs, but it will be tough for new players to match Pimco’s marketing prowess, Rosenbluth predicted.

Flows into fixed income ETFs are likely to continue at a rapid pace as investors hunt for income at a low cost. Many fixed income ETFs charge less than 20 basis points while providing yields above 2%. With the 10-year Treasury expected to remain below 2%, investors will find value in ETFs such as iShares Core Total Return U.S. Bond Market (AGG) and Vanguard Total Bond Market ETF (BND), Rosenbluth said.  

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