It has been a tough go of it lately for exchange-traded funds, what with topsy-turvy market volatility, global economic shakiness, uncertainty over when the Federal Reserve will raise interest rates and the potential for a down year in the stock market. And then there was the August 24 mini-flash crash when some ETF prices fell sharply against their net asset value, causing some investors to sell at steep losses before prices quickly regained equilibrium. Add it up, and the shine on the ETF industry during much of its rapid growth suddenly looks a little tarnished.
But all of these things are just bumps in the road, according to ETF experts who talked about industry trends during a panel discussion at the Morningstar ETF Conference in Chicago on Thursday.
“There are challenges, but I think the ETF industry will weather the storm,” said Tom Lydon, president of Global Trends Investments, and editor and proprietor of ETFtrends.com.
Ben Johnson, director of passive funds research at Morningstar, said investors are starting to focus on what they can control, which may make them better investors.
“We can’t control China, what’s going on in the emerging markets, what the Fed is going to do… we know what we can control things like costs,” he said. “More than anything else, that’s a huge driver of the growth of ETF industry at large.”
Matt Hougan, chief executive officer of ETF.com, said in times of market stress investors will make mistakes, but from an industry perspective, ETFs do well in market pullbacks.
“We saw $41 billion in inflows in the past quarter," he said. "Longer-term, diminished expectations of returns are great for the industry. When returns are down, the emphasis on cost is up.”
How investors react to “smart beta” products in a weaker market environment remains to be seen, as many investors who sought these products were looking for downside protection. As such, there could be a little bit of a backlash, Johnson said. Although these products are labeled “smart” by the industry, not all are really smart, he added.
“At the end of the day, it’s active management," he said. "Like any active-manager strategy, they will have their cycle of outperformance and underperformance. You can get in a bad cycle, and people may say, ‘it’s not performing as I expected.’ The risk you have [is] you get out when the style comes back in vogue. But we’ve seen the same behavior we’ve seen in other products for years and years.”
Hougan said it’s up to the ETF industry to educate investors about better investment behavior, including products like smart beta which focus on long-term trends.