The exchange-traded fund is now more than 25 years old. The inflows into the product have eclipsed those of mutual funds, and there are new funds breeding fast.
But proliferation is not necessarily innovation, and the rise in ETF popularity has caused alarm among some industry watchers. As the number of funds increases, advisors will have to spend more time researching to justify their selections.
“I think there’s a lot of fatigue right now as it relates to new products,” says Steve Dunn, the New York-based executive director and head of U.S. distribution at asset manager ETF Securities. “There are a fair amount of ‘me-too’ products out there, and I’m not sure that’s what clients are interested in right now.”
When the U.S. Department of Labor begins enforcing its fiduciary rule next year, investment advice within IRAs will be held to the same standard as advice delivered to qualified retirement plans. That means for the first time the fiduciary standard will be formally applied to ETF holdings within IRAs.
As a mostly passive, low-cost and transparent investment wrapper, the ETF as a product stands to gain from the new regulation. More than $140 billion in IRA assets will move into ETFs, according to Michael Wong, a Morningstar senior equity analyst.
With the DOL’s new disclosure requirements, advisors will have to spend more time
looking under the hood of ETFs to determine which ones best serve their clients’ needs and goals, and then sufficiently document their rationale, says Sylvia Jablonski, a capital markets and institutional ETF strategist at Direxion.
“Advisors are going to have greater responsibility to make sure their ETF recommendations are necessary and useful to the client,” Jablonski says. “They’re also going to have to be able to argue for why one fund is better than another similar fund, and not just for their clients’ sakes.”
Due Diligence Required
According to Morningstar, as of February of this year, 1,800 ETF products were listed on U.S. exchanges. Cerulli Associates estimates that there is now more than $3 trillion allocated to ETFs, and that ETF assets will double by 2020.
An additional level of due diligence is needed as indexes become more complex and as ETFs evolve to accommodate more active strategies, says Dunn.
“I think the factor space is interesting, but there’s still a huge amount of education and awareness needed for funds in this space,” Dunn says. “Advisors are just starting to become comfortable with single factors and using those products, and that’s why those products are becoming mainstream. Multi-factor and multi-weighted ETFs are going to take more time for people to understand. There’s not a huge amount of track record to look at.”