The curtain is about to drop on 2011, a year that will go down as a record-breaking period for the rapidly-expanding ETF industry. More than 300 exchange-traded products began trading this year, with dozens of issuers rolling out new products. While some of the new additions bear a striking resemblance to more established products on the market, the recent growth has been market by innovation that has made new asset classes and strategies available through the exchange-traded wrapper.
In a year full of ETF firsts, a few developments are particularly noteworthy; below, we highlight some of the events of the past year in the ETF world that have had the biggest impact on the way financial advisors and investors manage their portfolios.
1. Investment Discipline / Factor ETFs
One of the more exciting developments over the last year has been the launch of products that combine popular investment strategies with the exchange-traded structure, giving investors low maintenance access to stock screening techniques with the transparency and tax efficiency they’ve come to expect from ETFs. Russell has led the charge in this area with a complete suite of investment discipline and factor ETFs, though a number of other issuers have joined in as well. PowerShares‘ S&P 500 Low Volatility ETF (NYSEARCA:SPLV) has been one of the most successful new ETF launches of 2011, pulling in more than $700 million in just a few months [see Six Noteworthy ETF Innovations].
The strategies now available through ETFs include:
- Aggressive Growth (2 ETFs)
- Consistent Growth (2)
- Contrarian (2)
- Dividend-Focused (44 ETFs)
- Growth At A Reasonable Price, or GARP (1)
- High Beta (3)
- High Momentum (4)
- High Volatility (2)
- Low Beta (3)
- Low P/E (2)
- Low Volatility (8)
2. International Bond ETFs
International bond ETFs are certainly not a new innovation; the SPDR Barclays International Treasury Bond ETF (NYSEARCA:BWX) has been around since late 2007, and the first emerging markets bond ETFs launched just a couple months later. But 2011 marked a huge step forward in terms of the granularity of fixed exposure available through ETFs, as a number of targeted international bond funds began trading over the last 12 months.
Investors now have the ability to target a number of different bond markets outside the U.S., allowing them to achieve cheap and easy dollar diversification on the fixed income side of their portfolio. The new ETFs that started trading in 2011 include funds targeting:
- Australia (NYSEARCA:AUD)
- Australia & New Zealand (NYSEARCA:AUNZ)
- Canada (NYSEARCA:CAD)
- Germany (NYSEARCA:BUND), (NYSEARCA:BUNT), (NYSEARCA:BUNL)
- Italy (NYSEARCA:ITLY), (NYSEARCA:ITLT)
- China (NYSEARCA:DSUM), (NYSEARCA:RMB), (NYSEARCA:CHLC)
- Latin America (BONO)
- Asia (NYSEARCA:ALD)
- Europe (NYSEARCA:EU)
- Japan (NYSEARCA:JGBD), (NYSEARCA:JGBL), (NYSEARCA:JGBS), (NYSEARCA:JGBT)
3. Niche ETFs Gather Steam (And Assets)
The last year has also seen the launch of some very targeted products that focus on narrow sub-sectors of the U.S. or global market. Some of these products offer exposure to sexy industries, presenting a compelling investment thesis in high growth areas of the market. Despite some skepticism, some of these ETFs have actually hauled in some significant assets:
- S&P Health Care Equipment ETF (NYSEARCA:XHE): $21 million
- NASDAQ CEA Smartphone Index Fund (NASDAQ:FONE): $13 million
- Waste Management ETF (WSTE): $1 million
- Business Development Company ETN (NYSEARCA:BDCS): $9 million
- Fishing Industry ETF (FISN): $1 million
- Fertilizers / Potash ETF (NYSEARCA:SOIL): $24 million
- Solid State Drive ETN (NYSEARCA:SSDD): $11 million
- Cloud Computing Index Fund (NASDAQ:SKYY): $61 million
While some have complained about the hyper-targeted nature of many new ETFs being rolled out, it’s hard to argue that this is a net positive for investors. There are now more precise tools in the toolkit; most of these funds will be of little or no interest to the vast majority of investors, but those seeking to make a targeted play have the option to do so with all the benefits of the exchange-traded structure.
4. Alternatives ETFs Gaining Traction
Growth in ETF assets in 2011 wasn’t limited to traditional asset classes such as stocks and bonds; a growing lineup of “alternatives” ETFs has drawn the attention of advisors and individual investors looking to tap into strategies that were previously beyond their reach. The appeal of achieving exposure to these alternative strategies through ETFs is obvious; the exchange-traded structure allows for relatively low costs and complete transparency – welcome changes from most other products that tap into these corners of the market.
There were a number of new alternative ETPs to debut in 2011, and several corners of this market saw big cash inflows:
- Volatility ETPs: Interest in ETPs comprised of futures linked to volatility gauges soared over the last year thanks in part to the strong negative correlation of this asset class with global stocks. Innovation was also impressive in 2011, which saw the debut of the first VIX ETFs (VIXY and VIXM), a suite of single month-focused ETNs from UBS, and a handful of leveraged VIX ETPs.
- Managed Futures (NYSEARCA:WDTI): WisdomTree’s Managed Futures Strategy Fund was one of the most successful new ETFs of 2011, hauling in more than $250 million in assets in a relatively short period of time. This ETF utilizes both long and short positions in futures contracts tied to a trend-following strategy across various asset classes, including commodities, currencies, and U.S. Treasuries.
- Market Neutral ETFs: The last year saw the launch of several market neutral ETFs that combine long and short positions in stocks to deliver a portfolio that is expected to generate low volatility and isolate various return factors. Because market neutral strategies are generally not impacted by broad market movements, these ETFs can be effective as smoothing the overall volatility of a portfolio. QuantShares now offers a lineup of seven different market neutral ETFs targeting factors from size to momentum to beta.
5. Commodity Stock ETFs Thriving
Interest in commodities remained elevated in 2011, but it appears as if investors may be shifting their strategy for tapping into this asset class. Inflows into ETFs that target stocks of commodity producers accelerated dramatically this year, while interest in futures-based strategies waned. Through November 30, almost $7.5 billion had flowed into the ETFs that make up the Commodity Producers Equities ETFdb Category, led by the Market Vectors Agribusiness ETF (NYSEARCA:MOO) with about half of that total.
By comparison, the Commodities ETFdb Category, which includes broad futures-based products such as DBC and DJP, saw only about $585 million in inflows through the first 11 months of the year. It does, however, seem as if investors have retained their appetite for gold and silver; the Precious Metals ETFdb Category has seen about $3.6 billion in new cash come through the doors.
6. Emerging Markets Sector ETFs Finally Arrive
Given the tremendous degree of granularity available among ETFs offering exposure to domestic equities, it had been somewhat puzzling that options for tapping into emerging markets remain relatively blunt. One of the more noteworthy ETF innovations of 2011 was the launch of sector-specific emerging markets ETFs that significantly increase the options for investors looking to tap into the world’s most promising economies. No longer is emerging markets exposure through ETFs a binary decision; investors now have the ability to implement sector-rotation strategies, fine tune risk exposures and yield opportunities, and generally focus on the more desirable corners of what is a very broad asset class.
The EG Shares ETF lineup now consists of several different targeted options, including:
- Energy (NYSEARCA:OGEM)
- Financials (NYSEARCA:FGEM)
- Consumer Goods (NYSEARCA:GGEM)
- Telecom (NYSEARCA:TGEM)
- Consumer Services (NYSEARCA:VGEM)
- Health Care (NYSEARCA:HGEM)
- Technology (NYSEARCA:QGEM)
- Utilities (NYSEARCA:UGEM)
- Industrials (NYSEARCA:IGEM-OLD)
- Basic Materials (NYSEARCA:LGEM)
It’s been a bit surprising that these ETFs have been slow to build assets, given that most of them are the only options for sector-specific emerging market exposure. That certainly doesn’t mean that investors should stay away, but it’s probably wise to use limit orders when establishing a position.
7. More Commission Free Availability
The impressive success of the ETF industry has been built in large part on the competitive cost structures of these vehicles compared to traditional active mutual funds. And the cost efficiency of ETFs has only continued to improve in recent years, as many issuers have turned their attention towards minimizing other components of the total cost equation beyond simply management fees. Specifically, a number of commission-free ETF trading programs have popped up recently, beginning with the move by Schwab to mark its entrance into the space in 2010 and continuing ever since as brokerages and issuers have rushed to keep pace.
With the addition of commission free ETF trading programs by Scottrade (through its FocusShares lineup) and E*TRADE (which offers all ETFs from Global X, WisdomTree, and db-X), there are now more than 250 ETFs eligible for commission-free trading, including several of the most popular U.S.-listed products. The roster of commission free ETFs represents well more than $500 billion in AUM and just about every asset class. For investors looking to maximize their cost efficiency, it is now possible to drastically reduce or completely eliminate trading commissions.
8. Cost Competition Continues To Heat Up
The average ETF expense ratio rose in 2011 to about 59 basis points as the result of a growing lineup of actively-managed, leveraged, and more sophisticated exchange-traded-products that generally bring higher expenses. But the low end of the expense range expanded downward during the year, as issuers continued to compete with one another on the basis of fees. The most noteworthy innovation in this space was the launch of the lineup of FocusShares ETFs from Scottrade; many of those products are the cheapest in their respective ETFdb Categories, and FMU and FLG are currently tied atop the list of cheapest ETFs.
There have been some other interesting developments revolving around ETF expenses; Vanguard and iShares both cut fees on a number of their funds, while PowerShares is currently offering four of its financials-focused ETFs (KBWI, KBWR, KBWB, KBWC) with zero expenses.
9. Contango Killing Commodity ETFs
Exchange-traded products focusing on commodities have seen massive inflows over the last several years, as investors have embraced the exchange-traded structure as the most efficient way to tap into this promising asset class. But there have been some frustrations with commodity ETPs over the years, primarily related to the big gaps that arise over the long run between fund returns and changes in the spot price of the underlying resource. Contango has become a four letter word in some circles, creating stiff headwinds that can make it tough for commodity ETPs to deliver positive returns.
ETF issuers have begun to refine the methodologies behind commodity ETPs, rolling out products that are designed to mitigate the impact of the slope of the futures curve on bottom line returns. This trend started last year with the launch of the “contango killer” United States Commodity Index Fund (NYSEARCA:USCI), which explicitly considers contango when selecting component futures contracts. And it continued into 2011, a year that saw the launch of various ETPs that are designed to mitigate contango.
iPath rolled out a lineup of “Pure Beta” commodity ETNs in April; that lineup of resource-specific funds implements a four-step approach with the goal of matching spot returns. Also in 2011, Teucrium continued to build out its lineup of commodity ETPs with the introduction of funds focusing on soybeans (NYSEARCA:SOYB), crude oil (NYSEARCA:CRUD), sugar (NYSEARCA:CANE), natural gas (NYSEARCA:NAGS), and wheat (NYSEARCA:WEAT).
Each of those exchange-traded commodities spreads holdings across multiple futures contracts, utilizing a strategy specific to the individual commodity that is designed to eliminate the impact of contango on bottom line returns. Teucrium also offers a corn fund (CORN) that debuted in 2010.
Expect ETF issuers to continue to refine commodity exposure going forward; various companies have detailed plans for commodity-focused products that take aim at eliminating contango.
10. Currency-Hedged Equity ETFs
The roster of 2011 ETF launches includes a suite of funds from Deutsche Bank that are designed to strip out the impact of exchange rate fluctuations, essentially allowing investors to isolate the portion of returns attributable to stock price movements. This might sound like a minor product difference, but the impact of currency valuations on equity ETF performances can be material in certain environments. The recent decline of the euro has illustrated this quite nicely; the depreciation has exacerbated the losses felt by European ETFs.
For U.S.-based investors who believe the dollar will strengthen or who simply wish to avoid exchange rate exposure, this lineup of ETFs can be very useful:
- MSCI EAFE Currency Hedged Equity ETF (NYSEARCA:DBEF)
- MSCI Emerging Markets Currency Hedged Equity ETF (NYSEARCA:DBEM)
- MSCI Brazil Currency Hedged Equity ETF (NYSEARCA:DBBR)
- MSCI Japan Currency Hedged Equity ETF (NYSEARCA:DBJP)
- MSCI Canada Currency Hedged Equity ETF (DBCN)
Disclosure: No positions at time of writing.
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