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Active ETFs, Small ETFs and Other Trends to Watch in 2020

As we kick off the new year, market prognosticators are busy making their 2020 predictions. David Mann, our Head of Capital Markets, Global Exchange-Traded Funds (ETFs), offers some thoughts on trends and milestones within the ETF industry he thinks could come to fruition in 2020.

Is this really the fourth version of my New Year “predictions” posts? (Here are my 2019,  2018 and 2017 posts, if you’d like to revisit them.)

As in previous versions, you are not going to get my call on where the S&P 500 Index will be a year from now—which is probably a good thing! However, it is also impossible not to note that many of the major US stock market indexes were up more than 30% last year, which should impact the ETF flows for 2020.1 

Furthermore, last year we saw some major regulatory-related announcements impacting ETFs, including the adoption of the ETF Rule and approval of non-transparent, active ETFs. So, we probably need to incorporate the impact of those developments into my predictions for this year.

Here are my predictions for 2020.

Active Fixed Income ETF Assets Will Reach $110 Billion

Some recent trends worth highlighting that impact my prediction above:

  • Most active ETF assets (roughly 80%) are in fixed income funds.
  • Fixed income ETFs in general are becoming more and more popular; in 2019, fixed income ETFs accounted for almost half of the $334 billion of ETF inflows.2 
  • The ETF Rule was finally passed. It states that operationally, there are essentially no differences between active and index funds, and it also evens the playing field regarding the usage of custom baskets for all fixed income ETFs.

These are trends we have seen in our own active fixed income lineup, which stands at $1.8 billion AUM (as of January 2, 2020), with $1.5 billion of that coming in 2019. Fixed income is an asset class where we think active management can really shine.

So, how do I get to a figure of $110 billion in my prediction? Currently, active fixed income ETF assets under management (AUM) sits at $77 billion. Flows basically doubled in 2017 and again in 2018 before plateauing last year at $21 billion, matching the year prior. If we simply match again and there is no market appreciation in that asset class, they are already at $100 billion. I think we should likely exceed that easily, hence the extra $10 billion in my prediction. That gets us to $110 billion of active fixed income ETF assets.

We Will See More Smaller Funds Make the Leap 

Last year, the prediction regarding smaller funds was focused on large trades at multiples of the average volume, a topic that we have discussed repeatedly in these pages. I think investors have become more comfortable with the best practices when trading newer funds and understand that trading multiples of the average daily volume is now commonplace.

However, often the trading question will not even enter the conversation until a fund reaches a certain AUM. This actually has nothing to do with liquidity, a topic I talked about in the first year of this blog, or how people choose a restaurant, which I talked about more recently (you will have to click the hyperlink to understand that one). The conundrum is that people do not want to invest until the fund is large, but the fund will never get large unless people invest—quite the puzzle.

In 2019, there were 1,320 ETFs that started the year with under $200 million.3  Does anyone out there want to guess how many of those funds made it to $500 million? Only 10! Not even 1% of the funds made it from the $200 million milestone to the $500 million milestone, and that was during a positive market cycle with some real asset appreciation giving some AUM tailwinds.

This year we are starting with 1,491 ETFs that are under $200 million out of the almost 2,400 ETFs listed in the United States.4  I think this year investors will take the plunge and give more of these newer funds a chance. From there, size begets size.

By the end of 2020, I predict 25 of these funds will brag about reaching the $500 million milestone.

We Will See a Non-transparent ETF Reach $500 Million

As discussed earlier in this post, we have spent a fair amount of time discussing ETF-related regulations.  The first big one of last year was the passage of the ETF Rule. The second was the approval for all sorts of non-transparent ETF flavors.

You can click on those prior posts to get a sense of some of the headwinds these funds might face. In 2020, this will no longer be a theoretical exercise as there will live funds where we can watch the spreads, the trading and the investor interest. I have always been more of a “glass is half full” kind of guy, so I am pulling for these to work as envisioned.

Assuming that is the case, then I do not think it is that much of a leap for one of them to take off to the tune of $500 million of AUM.

Important Legal Information

David Mann’s comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user.

This information is intended for US residents only.

To comment or post your question on this subject, follow us on Twitter  @LibertyShares and on  LinkedIn.

What Are the Risks?

All investments involve risks, including possible loss of principal. Generally, those offering potential for higher returns are accompanied by a higher degree of risk.  Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices are affected by interest rate changes. Bond prices, and thus a bond fund’s share price, generally move in the opposite direction of interest rates. As the price of bonds in a fund adjusts to a rise in interest rates, the fund’s share price may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments; investments in emerging markets involve heightened risks related to the same factors. To the extent the fund focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a fund that invests in a wider variety of countries, regions, industries, sectors or investments. Smaller, mid-sized and relatively new or unseasoned companies can be particularly sensitive to changing economic conditions, and their prospects for growth are less certain than those of larger, more established companies. Historically, these securities have experienced more price volatility than larger company stocks, especially over the short-term. Performance of the funds may vary significantly from the performance of an index, as a result of transactions costs, expenses and other factors. For smart beta ETFs, there can be no assurance that a fund’s multi-factor stock selection process will enhance performance. Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. For actively managed ETFs, there is no guarantee that the manager’s investment decisions will produce the desired results.

ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.

For more information on any of our funds, contact your financial advisor or download a free prospectus. Investors should carefully consider a fund’s investment goals, risks, sales charges and expenses before investing. The prospectus contains this and other information. Please read the prospectus carefully before investing or sending money.

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1. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results. There is no assurance that any estimate, forecast or projection will be realized.

2. Source: Bloomberg, as of 1/2/20.

3. Ibid.

4. Ibid.

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