Nagging market disruptions in the form of an historic Fed rate hike, plunging commodity prices, and the sudden collapse of the Third Avenue junk bond fund might require some portfolio rejiggering, but not enough to derail the positive momentum in the ETF space.
Cerulli Associates is forecasting that total exchange-traded fund assets will reach $6 trillion by 2020, which would mean more than doubling the current total industry assets.
“As new investor segments continue to acclimate to ETFs in their portfolios and sponsors develop new products, ETF assets are expected to climb as the industry enters its second decade,” said Cerulli analyst Jennifer Muzerall.
Through November, the ETF industry saw $200 billion worth of inflows this year, which was fueled by innovation and new players entering the space, according to Todd Rosenbluth, director of mutual fund and ETF research at S&P Capital IQ.
“A lot of what happened this year involved investors gravitating toward low-cost and well-diversified ETFs, which is a trend that will continue,” he said.
Mr. Rosenbluth cited currency-hedged ETFs, in particular, as a strategy that has become a popular way to take advantage of the surging U.S. dollar.
“Whether it continues will depend on the dollar continuing to strengthen, but I don't think anybody expected that to be such a prevalent theme this year,” he said.
The major asset managers that migrated to the ETF space in 2015 include John Hancock, Goldman Sachs Asset Management and DoubleLine Capital.
But perhaps one of the biggest endorsements for the ETF space was that high-yield bond ETFs were able to manage the
market's reaction to Third Avenue Management's abrupt closing and freezing of investor assets in its focused credit fund.
“The lack of liquidity that happened to Third Avenue has caused investors to pull money out of high-yield mutual funds, and they may [now] gravitate toward high-yield ETFs,” Mr. Rosenbluth said.
Dave Mazza, head of research for SPDR ETFs at State Street Global Advisors, said the spike in
junk-bond volatility in the wake of Third Avenue closing was managed with relative order across the high-yield ETF space, despite concerns that the ETFs themselves might be more liquid than the underlying bonds they hold.
“We saw three consecutive days of record volatility in those ETFs, and we saw some outflows, but this week we started to see some inflows,” he said.
The next challenge for bond investors, he added, will be
anticipating the Fed's 2016 monetary policy strategy.
“Right now there is tremendous uncertainty when it comes to the bond market because of the need for continued information from the Fed regarding the direction of interest rates,” Mr. Mazza said.
According to an SSGA report that came out just prior to the Federal Reserve's quarter-point interest rate hike announcement on Wednesday, sluggish global growth and subdued inflation are the two primary issues that will challenge investors in the year ahead.
Couple that with the typical post-rate-hike market volatility and a narrowing spread between the yields of shorter- and longer-term bonds, and the outlook for broad, passive indexed bond investing loses its luster, Mr. Mazza said.
“Most people have spent years tweaking and working on their equity portfolios, and not giving as much attention to fixed income, which has worked pretty well for the past 30 years,” he said. “But the Barclays [U.S. Aggregate Bond Index] has a very unattractive yield per unit of rate risk, which means you're not being compensated for taking on that risk anymore.”
As the Fed rolls into its first rate-hike cycle in nearly a decade, Mr. Mazza said investors will need to be more nimble and adventuresome.
“Convertible bonds are a bit misunderstood, but when we expect great volatility, converts can allow you to get paid while you wait, and can be a lower-volatility way to play equities,” he said. “We also think the high-yield bond space is becoming more attractive.”
Yes, high-yield bonds; the same asset class that seemed radioactive in the immediate aftermath of the Third Avenue fund collapse.
It would be difficult to imagine anybody pitching high-yield at this time if the ETF space were unable to manage the flood of trading in and out of that space over the past week.
“High-yield has gotten a lot of attention, but we think it still represents an opportunity for patient investors,” said William Belden, managing director of product development at Guggenheim Investments.
