Allocations to index funds and ETFs have risen rapidly, given the regulatory changes and the desire to stay competitive are driving distributors to search for more cost-efficient wrappers. With the qualities that attracted early adopters, ETFs have now become increasingly valued by a growing set of investors.
In summary, there are three reasons why indexing has disrupted portfolio construction in a positive way and how ETFs have helped investors become much more efficient:
You can save time
Determining which managers can deliver true alpha is a task requiring significant time, skill and effort. Indexing helps to reduce the governance burden on continually searching for managers that can deliver true alpha.
You can manage risks
Often, investors can find that they are taking unintended risks within their portfolio, as a side effect of product selection choices. Indexing gives you more control of your portfolio, reducing the potential for misalignment and unintended risks.
You can curb costs
A selection of the best managers does not always make the best portfolio. Indexing is not only about lowering overall portfolio costs, but about finding potentially more efficient ways to achieve similar outcomes.
They persistenly work
There are 5 rewarded style factors: value, quality, momentum, small size and low volatility. All have been persistent drivers of returns across asset classes for decades.
They outperform markets
Over the past few decades, most investors would access factors through actively managed strategies. Factor ETFs provide access to factors in a cost-efficient and transparent way.
They enhance portfolio performance
Factor ETFs can enhance additional diversification and improve potential return benefits, even during volatile markets.
Complex markets
With the increasing complexity of global markets, new technologies and expanding data sources can help clients understand where returns are coming from. Investors who know the factors that drive returns in their portfolios choose the right mix of assets and strategies for their needs.
Geopolitical context
Markets are whipsawing as the spread of COVID-19 cases has triggered unprecedented market volatility. Such dislocations usually are short term, and implementing factors into the portfolio can help position it defensively.
Regulatory changes
Stricter regulatory provisions (FIDLEG/ FINIG) and market pressure to increase cost transparency, are generating lower margins and revenues within the asset management business, driving a business model transformation with a shift to low-cost investment vehicles, such as factor ETFs.
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