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Tom Lydon, ETF Trends (161 clicks)
ETF investing
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As the champagne corks ushered in 2007, investors celebrated more next generation exchange traded funds [ETFs] that promise an exciting variety of targeted new offerings. All grown-up, with everywhere to go, new ETFs continue to hone their appeal for the investing public that craves reduced expenses, diversified risk and targeted investing opportunities exceeding the broad-market benchmarks.

Investors have every reason to be optimistic. The evolution of ETFs sped up significantly in the last year alone—as improving opportunities for jumping into tailor-made sectors that can pack a punch in the way of concentration, while enabling investors to diversify across a wide-array of stocks. The selection is vast and exciting. While new ETFs pop up weekly, their evolution is still just beginning. Here are ten ETF trends we expect to see in 2007:

1) Global ETFs will continue to outperform their domestic counterparts.

Despite the fact that the Dow Jones Industrial Average has staged a 4-year rebound, international investments continue to lure investor cash—and in a huge way. Recent data show that $124 billion of new money has flowed in equity mutual funds this year (including ETFs), with a whopping $110 billion, or 89%, flooding the international arena (AMG Data). This rush to international funds is staggering given the enormous success of corporate America. Last year, across the board, global ETF shares trounced domestic benchmarks, including SPDRs Trust (SPY), Diamonds Trust (DIA) and Nasdaq 100 Trust (QQQQ).

In the new year, we expect international ETF offerings to maintain the foreground. Looking at 2006 numbers for global equities, their growth dwarfs their domestic benchmark counterparts. Equity fund providers will continue to respond to the currently insatiable demand for international investing as international market valuations remain relatively cheap and the burgeoning gross domestic product numbers for specific regions outstrip those of the U.S. Case in point, many ETF providers have launched or filed to launch international ETFs for specific regions, including Asia Pacific, Asia Pacific Emerging, China, Europe, Europe Emerging, other regions, and with varying degrees of market capitalization. The significance of this development is just one indication of the degree of innovation and excitement for ETFs for the coming year.

2) Actively managed ETFs hit the marketplace with a thud.

What was billed as the next generation for ETFs will go over like a lead balloon with investors. Active managers have taken a run at actively managed ETFs—and why not? The enormous success of ETFs has active managers scrambling to entice investors back to active management and big expenses. It won't happen. Why? The whole point of an ETF is to avoid active management and their expenses. ETF investors have come too far—they have stepped out of the frying pan and they're not treading back into the fire. They may lure some up-until-now active manager devotees, but there's no staying power. ETFs have their roots in sectors and sub-sectors of indexes.

As such, investors will look to indexes for the benchmarks, not active management. Actively managed ETFs have no track record—no benchmark. There is no guarantee a mutual fund manager can provide performance results with an ETF. And, two-thirds of ETF assets come from institutional investors who are looking to find allocations to specific asset classes that also include targeted industry groups and specific global regions. These institutions know what they're looking for, and where to find it. They don't need a manager to do their research.

3) The ranks of ETFs will continue to explode.

Tracking indexes enables investors to capture markets, sectors and capitalization parameters. The ETF universe has exploded in just the last couple of years—and for good reason: minimal expenses and innovative offerings target growth through diversified risk. And, they will become even more intriguing as world-class presenters sharpen their competitive instincts to stay at least a step ahead. What's in the pipeline? Natural resources, bonds, individual emerging market countries, and targeted market capitalization strategies all make for a very exciting year ahead.

Big-name fund providers will continue to pump out more lean, mean asset-building machines for every kind of investor, swelling the ranks of ETFs. Some 345+ targeted and broad-market ETFs collectively boast a current market capitalization of $410 billion in assets. There are predictions that with ongoing new offerings and heftier investments down the road we will see an overall ETF market capitalization upwards of $2 trillion by 2011—just four years from now.

4) Fidelity finally joins the party.

Even as big name ETF providers continue to expand their offerings, the big cheese continued to stand alone. Back in 2003, Fidelity tested the ETF waters with its Nasdaq Composite Tracking Index (ONEQ) fund—the name proved prophetic as it remains their only "ONE." Fidelity's cash cow continues to be their incredibly lucrative 401(k) plan offerings that carry a much wider profit margin by utilizing their conventional mutual funds compared to the skinny expense ratios of ETFs. Reticent to cannibalize their own market, the giant has remained committed to active management and the hefty fees. However, Fidelity cannot sit out forever and as plan producers feel more pressure to reduce expenses, Fidelity will be forced to enter the ETF game.

5) The emergence of emerging markets.

Emerging market ETFs will expand into even more individual countries. Right now, most international ETFs represent established foreign indexes, but the big boys are moving into the developing markets, as well. Barclay's and State Street are looking into more individual country offerings. And, there's plenty more on the docket for China—possibly including mid-cap and small-cap exposure to capture the awakened giant. Get ready for India, Turkey, Russia and Eastern Europe to come on board with increased and improved individual offerings.

6) Lower fed rates boost bond ETFs.

The expanding U.S. economy has been giving us some sign of slowdown. The housing situation, in particular, has many wondering if the Fed may contemplate lower rates in 2007. Such a move will give bond ETFs the impetus to move upward. Fixed income investors can use bond ETFs to capitalize on a lower interest rate environment. Certain fixed-income ETFs are influenced by interest rate movement. In fact, they respond inversely to interest rates. As such, when rates increase these bond instruments will actually go down in value. Conversely, when rates decline, the value of the ETFs will go up—regardless of treasury or corporate bonds.

7) ETFs get ready for retirement.

Get ready for the billion dollar struggle! Corporate America and their employees want ETF offerings for 401(k) plans. The expenses associated with 401(k) plans are exorbitant—just the way the fund providers like them. But, administrators have seen the ETF light, and they want more—and they're likely to get what they want. The large providers won't deliver easily—they have plenty to protect—and they're just not motivated to give up the big fees. But, some of the usual ETF suspects are poised to enter the fray, setting in motion a wonderful power play in which the corporate sponsors and the employees will come out on top. The cost-savings potential is a great motivator for the battle to demand ETF inclusion in 401(k) plans.

8) The next big gold rush.

More specialized commodity ETFs are on their way. There's enormous pent-up demand for an increased selection of commodities and natural resources ETFs. The new offerings in this arena will make it even easier for investors to participate. Tradable gold products—including gold trusts and gold bullion—are on the list of expanded offerings. And, an increased supply of oil, metals, currency, energy and water will make investments in commodities sector more mainstream for investors. Big players have given us some very credible benchmarks for smart commodities and natural resources investing. And even CalPERS—the world's largest pension fund—has moved into commodities ETFs. What's more? We're seeing even more specialized sectors move into the arena, as well. Can you say "nanotechnology"? ETF investors can learn all about it.

9) Bear-market ETFs.

The Bull has taken Wall Street by storm for the last four years running. Every savvy investor knows that the streak is long in the tooth now. This is a good time to learn about the increased offerings for long/short and high beta ETFs that pack large asset class exposure with less money—leverage. We all love a bull market, but you can learn to love a bear, too. ProFunds has some great institutional offerings that run inverse to the market. Keep a close eye on what other ETF providers are offering in regards to long/short and high beta ETFs.

10) And in the "Truth Is Stranger Than Fiction" category...

The big mutual funds boom of the 1990s had fund providers throwing everything—including the kitchen sink—into new funds. Adding some 400–500 new funds a year, they all got sloppy. Complacent active managers, earning fat paychecks and underperforming simple benchmarks, finally got under the skin of investors who learned too late they were paying too much to earn too little. Predictably, we see hundreds of active funds folding or merging to bury the putrid track records. Those who remain standing—for now—are scared. They know they are under the microscope to deliver. Ironically, guess how they're attempting to keep their fat out of the fire: they are buying up ETFs to bolster their abilities to get closer to the benchmark. Maybe 2007 will be the year active mutual fund shareholders learn the virtues of ETFs. Amazingly, that epiphany may come at the hands of the active managers themselves.

Yes, indeed, 2007 is going to be another big year for ETFs. This new year promises continued refinements for our favorite investment tool. Innovative, new breeds of funds will continue to sharpen investors' abilities to capture the markets that matter. New fund issues, new opportunities and new markets: it's going to be a very happy new year!

Source: Ten ETF Trends To Expect In 2007