ETF analysis: How to profit from two of the hottest themes in town

Last year was a stellar one for exchange traded funds (ETFs). Global ETF assets hit a new high of $4.7 trillion (£3.4 trillion) as at December 2017, up from $3.5 trillion a year earlier, according to Morningstar data. That was achieved thanks to record-high inflows of $665 billion. The unstoppable rise of ETFs is testament to their appealing features, chiefly low cost, flexibility and transparency. These traits allow investors to use ETFs as asset allocation tools to lower the cost of their portfolios.

So after such a successful year in 2017, what’s in store for 2018? While it’s impossible to predict which direction capital markets will go in, it is fair to assume that ongoing structural and regulatory changes in the asset management industry, combined with continued innovation on the product development front, should make for another exciting year in the ETF industry.

In Europe the pan-European Markets in Financial Instruments Directive (Mifid II), which came into force at the start of January, is expected to boost investors’ confidence in ETFs by providing more transparency around ETF trading and liquidity. This extensive new piece of regulation could also lead to more retail investors embracing ETFs as a result of tighter restrictions on commission payments by asset managers to distributors. Because ETFs don’t pay commission, they are likely to benefit from the level playing-field.

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Against this backdrop, the number of ETF choices will continue to grow. Investors can also expect more options in the fixed-income and smart-beta departments this year, as ETF providers and new entrants busy themselves launching new funds. In addition, multi-factor equity funds, which combine a range of factors such as value, low volatility, size and quality have proliferated in recent years and will remain an area of focus.

It is also fair to expect more thematic ETFs to launch this year. Robotics, among all, has proved a popular theme, with the top four robot-focused ETFs now holding close to $6.7 billion in assets between them. The Irish-domiciled iShares Automation & Robotics ETF alone pulled in an impressive $1.2 billion last year.

Another key area of focus for ETF providers is environmental social and governance issues. Currently,138 ETFs incorporate environmental, social and governance criteria in the stock selection process, according to Morningstar data. Last yearsaw a record 38ESG-centric ETF launches, compared with 30 in 2016 and 14 in 2015. This year is shaping up to follow the same upward trend.

Gender equality trend

One fashionable theme ETF providers are pinning their hopes on is gender equality and diversity. Four gender-flavoured ETFs have hit the shelves in the past four months, including two in Europe offered by Lyxor and UBS. Both track similar indices developed by index provider Solactive and Equileap, an organisation that promotes gender equality in the workplace. The two global gender equality indices focus on companies that are market leaders in terms of gender equality. iShares is also reported to be considering jumping on the bandwagon with a Thomson Reuters Inclusion and Diversity Ucits ETF in Europe.

Diversity is an increasingly important topic for institutional investors and one that resonates with millennial investors. Acynic might dismiss gender and other ESG-focused products as fads, and only time will tell if this feel-good investment will prove to be good for portfolios. That said, one clear advantage of ESG strategies is that investors are likely to stick with them.

Finally, expect to see further ETF fee reductions this year. The price war that started five years ago in the passive fund industry- is far from over.

Hortense Bioy is director of passive fund research, Europe, at Morningstar .

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