The world of ETFs is experiencing a revolution that is possibly still in its early stages, despite the notable increase in the global trading of this type of instrument. Jon Maier, Chief ETF Strategist, and Carlos Brito, Head of ETFs LatAm, at J.P. Morgan Asset Management, spoke with Funds Society about the evolution of the market, its present, and its future.
Exponential Growth
Since these instruments were created, they have recorded exponential growth, but especially in the years of the present century, asset management in ETFs has multiplied in the United States, the most important market in the world, and in the rest of the markets.
The first ETF in history was launched in 1993, an instrument indexed to the S&P500, according to J.P. Morgan, and since then exceptional growth has been recorded.
“If we consider from 1993 to date, we observe that since the year 2000 there has not been a five-year period in which ETFs have not doubled their assets under management; the 13.6 trillion dollars in assets in the U.S. ETF market far exceed an economy as important as Mexico’s, which last year reported a GDP of around 1.85 trillion dollars,” says Jon Maier.
“Additionally, if we consider that globally assets under management amount to just over 20 trillion dollars, then we could say that if the ETF market were an economy, it would be the second most important in the world, only surpassed by that of the United States, which is worth around 25 trillion dollars, and above the Chinese economy, which is close to 18 trillion,” explains Carlos Brito.
“This speaks to the adoption that ETFs have recorded worldwide, with exponential growth. But we also consider that this is just the beginning because one of the major trends focuses on the entire area of active ETFs, which are ETFs that are no longer indexed, no longer replicate an index, but rather have a portfolio manager,” says Carlos Brito.
“We carry out a fundamental analysis of which companies we believe have the most value, and those companies are given overweight in the portfolio, while those we are not confident in will have an underweight or will not even enter the portfolio,” says Jon Maier.
We are facing the evolution of the market in another phase that could certainly further boost trading and drive other regions beyond the United States and Europe, the latter considered the second most important market.
Active ETFs, the Great Structural Change
The boost in the ETF market in recent years is not only the result of the need for diversification and the search for returns in investments; there were additional factors, and perhaps more important ones, that explain it.
“In 2019 there was a structural change in the ETF market; what happened was that the SEC in the United States greatly relaxed the rules for launching active ETFs (ETF Rule 2019); for example, in the use of derivatives, it also made it possible for certain participants, such as brokers, who as liquidity providers can create new ETF shares,” explained Jon Maier.
“So those brokers, instead of delivering a specific basket of stocks, can deliver a basket that may include some stocks along with some cash, and if the portfolio manager agrees, they accept that basket. That gave it a lot of flexibility and triggered the active ETF market,” said Carlos Brito.
The Future Is the Present
Transparency, liquidity, and cost efficiency are just some of the characteristics that have driven ETFs to perhaps become the most attractive investment vehicle in global portfolios today. And it is likely what will maintain interest for a long time.
For J.P. Morgan’s strategists, the exponential growth of the ETF market is still in its early stages, despite all the progress made and the figures showing increasing flows.
“The vast majority of active ETFs, for example, are 100% transparent. We know exactly what the ETF is invested in in real time; that does not happen with mutual funds. For us, the ETF is today a much better technology than the mutual fund.”
Flows into the market are growing exponentially in the ETF market, and in the segment of active instruments this is growing more every day; today, out of every dollar that enters the market, 42 cents go to active ETFs—almost half of the new money in the United States is going into this type of option.
Likewise, J.P. Morgan’s strategists believe that the adoption of active ETFs in fixed income still has room to grow.
“We believe that many benchmarks are constructed in such a way that what happens now is that the largest companies have the largest percentages of the portfolio, but it is very likely that given the high levels of debt, there is a lot of opportunity to select which companies we want and which we do not in the portfolio; that still remains,” explains Carlos Brito.
“And then, we believe there is another very powerful force, which is this transition toward changes with the financial advisor; previously these advisors operated opaquely, today in the United States there is a transition toward a model of much greater transparency, which will benefit the market because it creates the incentive for the banker or advisor to have the most efficient investment models.”
Thus, while it is true that the ETF market has already experienced explosive growth, we are only seeing the first phases, conclude J.P. Morgan’s ETF strategists.
