Matt Hougan is CEO of Inside ETFs, a division of Informa PLC, and one of the driving forces behind some of the world's largest ETF conferences and webinars. InvestmentNews senior columnist John Waggoner spoke with Mr. Hougan on the growth in ETFs, what's new in the industry, and, of course, bitcoin.
John Waggoner: Last year saw the biggest inflows to ETFs in history. What's driving those flows?
Matt Hougan: Multiple factors. Last year saw $477 billion in ETF inflows, twice as much as any previous year. We're in a generational shift from high-cost to low-cost investment products. People are demanding products come with low fees, and ETFs are more efficient vehicles than mutual funds. And there's also the shift from active to passive. People are moving from active to passive because of both cost and dissatisfaction. Active managers have failed to beat the market, and that has become more pronounced after years and years of terrible performance. The demand for lower-cost investment products comes from the fee pressure advisers are feeling. They can't have a 1% fee for themselves and funds that charge 1%. They either have to cut fees or change to cheaper investment products — a lot of it is self-serving.
Advisers are seeing fee pressure, too. If I were to make a 10-year bet, I'd say adviser fees will come down significantly. But right now, they will fight tooth and nail to protect that 1%. The other piece that gets overlooked is that as ETFs get bigger and better, trading costs come down and tax efficiency increases. Now we see large institutions using ETFs as core holdings because it's cheaper to hold ETFs than the underlying securities. We don't think 2017 was the high water mark: 2018 will be a record, too.
JW: Are we reaching the end stage of ETF innovation? Has the industry thrown enough ETFs against the wall to see which ones stick?
MH: They are fighting over the scraps. Do I think there will be a new fund that accumulates $100 billion in assets? I'd be surprised. But there are legitimate funds that will create $1 billion in assets — not that there aren't some great new funds out there. One example: Republican Policies Fund (GOP) and Democratic Policies Fund (DEMS), which take advantage of the fact that government policy affects investment returns. If the Republicans are successful, for example, defense stocks will do well, and companies that are repatriating earnings will do well. Another is QuantX Dynamic Beta US Equity ETF (XUSA). Most factor-based funds are backward-looking. What this fund did was look at the options market and invests in those with the highest bullish skew in the market. It's a legitimate hedge-fund strategy in a liquid, low-cost ETF.
JW: How useful are smart-beta funds, really? If their aim is to replicate active management strategies, don't they have the same cyclical success and failure rates as actively managed funds?
MH: They are useful if investors are willing to buy and hold them for seven to 10 years or more. They are an invitation to underperformance if you buy and hold them for a shorter period. It's really hard for investors to buy the stuff that's out of favor. For example, do I think value ETFs will outperform in the next 10, 20 years? Sure, but you have to hold them for the very long term. It's true of every other factor, too. For example, there are significant periods where size factors outperform, or quality factors outperform. The Russell 2000 trailed the market for two decades after it was started. People need to understand that factors operate on glacial time cycles.
JW: Equity ETFs have had the lion's share of asset growth. Do you see other areas that might take over?
MH: Extremely low-cost funds will gain the lion's share. Two contrarian areas. I think that rotation into commodities will start. It's one of the few asset classes not trading at all-time highs. And the growth we saw in fixed-income ETFs will accelerate as more institutions use them as core positions. I don't think fixed income will eclipse equity, but I think the gap will narrow.
JW: Will there be a bitcoin ETF this year?
MH: We'll see. It's an asset people want to own, and an ETF is an efficient mechanism to own it. I don't think the Securities and Exchange Commission is in any hurry to approve it. It's a given that a futures-based bitcoin ETF will be first, but what people want is a physical product. A diversified basket of crypto-currencies would be vastly superior to a bitcoin ETF. There's not an elegant custody solution that scales easily in lesser cryptos, but it's a solvable problem.