For most investors with a 10-year plus horizon, the trend toward simple, passive index investing, at least for core positions, is irrefutable. Just look at the fund flows if you have any doubt. As Matt Hougan, CEO of ETF.com, said at the recent Insider ETFs conference, actively managed mutual funds in the core categories are “dead men walking.”
Some suggest it’s an investor revolution against Wall Street - what could be simpler than directly owning, at the touch of an order button, an entire index? But consider: Goldman Sachs issued its first ETFs in 2015, joining other old-school firms in the space like J.P. Morgan and John Hancock. There were, ETF.com notes, almost two dozen first time ETF issuers in 2015, many of them long-time asset managers. New funds are launched at a rate of one a day.
Many of the new entrants are increasingly esoteric. There are funds for specific industries, like healthcare and food; some use leverage, some are built to mute the impact of volatility on a portfolio, while others are built to profit from it. There are funds based on macro-economic trends, bets on interest rates and on single countries. There are an infinite number of ways to slice up the markets.
Many of the new issues follow some kind of non cap-weighted, factor-based index - the so-called smart beta ETFs. Investing via quantifiable factors, like valuation, size or momentum, are long-proven strategies, and it’s what active managers do (or did.) Some estimates suggest these factors can account for over 70 percent of some active mutual fund manager’s returns. Then consider that those once-costly strategies can now be had for a few basis points, and you can understand why Wall Street is taking notice.
And therein lies a problem; there are quickly becoming too many ETFs of too many varieties and complicated flavors. A typical advisor can’t make sense of them all, nor understand how to combine them into portfolios. ETF strategists will do that for you, of course, and I’m sure there will be more model portfolios coming from the asset management firms themselves.
This threatens to turn the ETF landscape into a gentrifying neighborhood, where pioneers who see the potential in an offbeat corner of the town are followed by the bandwagon jumpers, property developers and chain stores. Soon, the cool new spot looks a lot like the old ones.
The low-cost index approach is clearly winning the war for investor dollars, but that’s not going to hurt traditional Wall Street; They say big asset managers are slow to adapt, but I disagree when money is on the line. The people who work there are very smart, and the firms very good at creating complexity. Then they offer to help investors make sense of it all—for a fee.