2013 was a great year for the ETF industry, thanks to strong flows in equity funds, a host of new launches, and demand for low cost products. Due to these trends, assets under management for the total industry crossed the $1.6 trillion level, while the total number of funds surpassed the 1,500 mark.
And 2014 is shaping up to be a solid year too, as many investors remain reasonably bullish on the economy, while Europe is also surging back. Assuming that the QE taper doesn’t impact the economy too much, there is plenty of reason to think that stocks can march a bit higher this year as well (see 7 ETFs to Buy in 2014).
Yet even with this solid backdrop, the ETF industry could be in for some surprises this year. There are plenty of untapped markets out there, while there are at least a few dozen funds that have failed to capture investors’ interest on the other side of the coin.
Given this, it could be a rocky year for some issuers, though others seem well positioned to take advantage of the market trends. In particular though, we look for the following five predictions to come true for the ETF industry, and dominate the news cycle this year:
New Income ETFs Dry Up
Despite the taper threat, new income ETFs continued to hit the market. A plethora of new products with an income focus launched in 2013, giving investors a variety of options to target income-investments be they in the form of covered-calls, dividend growth, or dividend quality.
While these have been welcomed additions to many investor portfolios, you have to wonder how many more the market can hold. We have already seen a few launched from First Trust in 2014, and I am skeptical that the market will be able to stomach too many more (read 3 Best Dividend ETFs of 2013).
For example, in just the last two months of 2013, investors saw several ETFs hit the market with an income focus. These include a variety of strategies such as the Cambria Foreign Shareholder Yield ETF (FYLD - ETF report), the Horizons S&P Financial Select Sector Covered Call ETF (HFIN), and the ETRACS Monthly Pay 2xLEveraged Closed-End Fund ETN (CEFL), just to name a few.
Bottom Line: The intense flow of income ETFs slows to a trickle, especially as competition heats up and rates continue to rise.
Emerging Markets Rebound
Although flows into equity products were pretty intense for U.S.-focused funds, emerging markets saw heavy outflows. (EEM - ETF report) and (VWO - ETF report), the two most popular emerging market funds on the market, were the biggest losers in terms of assets with each losing more than $8 billion. Other emerging market funds also led the list of the biggest outflows as concerns over the taper, a strong dollar, and growth prospects hampered these securities.
However, many of these emerging markets have stabilized in recent trading, and with strength projected in key markets like China, they could be due for a rebound. Plus, with developed markets performing so well, it could lead to some serious strength for exporters in the developing world.
Bottom Line: Emerging Market ETFs will see a rebound, and solid inflows for 2014.
Senior Loan ETFs Become More Common
Even with heavy bond losses, fixed income investing was relatively popular among investors. And with the advent of senior loan ETFs, many found a new favorite way to invest in bonds (Read Senior Loan ETFs: The Best Bet for Rising Rates?).
That is because these senior loan securities give exposure to fixed income, but greatly reduce interest rate risk. This makes these securities perfect in rising rate environments, while still paying out a solid level of income to investors.
Investors really embraced this approach in 2013, as (BKLN - ETF report) saw the most inflows out of any bond ETF, while its competitors—SNLN, SRLN, and FTSL—all saw decent interest too. I think this trend will continue in 2014, and that we will see more funds, and segmentation, in this in-focus corner of the bond world.
Bottom Line: Senior Loan ETFs will stay hot, especially if rates continue to tick higher.
Niche Strategy ETFs Will Surge in Popularity
Although broad market funds did quite well in 2013, so-called niche strategy ETFs stole the show and actually outperformed. These include funds that focus on items like stock buybacks (PKW - ETF report), IPOs (FPX), and spin-offs (CSD), all of which easily beat the S&P 500 over the past year. In fact, all three have seen gains more than 40% over the past year, compared to a nearly 28% for SPY in the same time frame (See Best ETF Strategies for 2014).
These saw decent levels of interest from investors in 2013, but I think this will really pick up in 2014. After all, all three of the aforementioned funds have a solid methodology and have shown a history of outperformance, two factors which are likely to attract more assets in the months ahead.
Bottom Line: After a great year, investors will really start to take note of niche strategy ETFs.
New product launches hit 100, so do closures
While the focus might not be on income funds in 2014, there will undoubtedly be a number of new niches that are targeted by ETF issuers. There are hundreds of funds already in the pipeline, and more mutual fund companies will likely dip their toes into the water. Charles Schwab and other surging issuers will also look to expand their lineups, making further inroads in this competitive industry, and pushing total funds launched over 100 again this year.
However, I think we will see a big round of closures too in 2014. Issuers will finally see the writing on the wall for many underperforming funds which have failed to attract assets despite pretty favorable conditions. So while 2013’s closures might have been around 60, I look for 2014’s total to get back closer to 2014’s level and cross the 100 mark.
Bottom Line: ETF launches remain at a solid pace, though closures will pick up as underperforming funds fall by the wayside.
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Author is long CSD.