Back to the Future

Monday, October 10, 2016 - With the third quarter now in the rearview mirror, we outline key takeaways from 3Q, their impact on the ETP market and potential market moving events to which investors should pay attention in the final quarter of 2016. Like Columbus, let’s explore....

Familiar macroeconomic concerns continued to dictate market behavior and investment flows in Q3, as geopolitical risks and uncertainties, stagnant global growth, persistently low returns and the resultant hunt for yield, inflating asset prices, and the direction of global monetary policy loomed large. Despite an initial pullback following June's unexpected Brexit vote, global markets steadied in the third quarter as global central banks remained accommodative and economic fundamentals improved.

Against this backdrop, U.S. listed ETPs continued to gather assets at an impressive rate with investors pouring $92 billion in ETPs in Q3. As calm was restored to the markets and broad-based equity indices soared to record highs, equity ETFs led the industry in inflows, attracting $55 billion in fresh assets. The preponderance of these inflows were directed towards large-cap equity ETFs, with the SPDR S&P 500 ETF Trust (SPY) leading in inflows, with $13.27B in new assets and the tech-heavy Nasdaq-100 Powershares QQQ Trust (QQQ) garnering the fourth most assets of the quarter with $2.18B.

In the absence of negative economic data and amid historically low interest rates across developed markets, investors returned to riskier assets in Q3. This risk-on rally is reflected in our fund flows summary, where several cyclical equity sector, high-yield, and emerging markets ETFs were among our top quarterly leaders in inflows. The Vanguard Information Technology Index Fund (VGT), iShares iBoxx $ High Yield Corporate Bond ETF (HYG), and the iShares MSCI Emerging Markets ETF (EEM) attracted $545.16M, $810.4M, $4.11B respectively amid this stabilizing backdrop and search for growth and yield.

As the quarter came to a close and expectations for an end of year Fed rate hike increased, bond-proxy ETPs fell out of favor. This is reflected in our fund flows summary, where two defensive sector ETPs, the Consumer Staples Select Sector Fund (XLP) and the Utilities Select Sector Fund (XLU), and a long-dated treasury fund, the iShares 20+ Year Treasury Bond ETF (TLT) were among the leaders in outflows for the quarter, bleeding $602.39M, $476.16M, and $595.61M respectively in assets.

Aside from the Fed tightening, another potential catalyst for future ETP flows may have come from this week's announcement by BlackRock that they will, in preparation of the impending DOL Fiduciary Rule, cut fees on 15 of its flagship ETFs. The fee reductions affect about $217 billion in assets, nearly 17% about BlackRock's $1.3 trillion in ETF AUM, and some of the most widely followed ETFs in the marketplace, including the $79.08B iShares Core S&P 500 ETF (IVV) and the $41.39B iShares Core U.S. Aggregate Bond ETF (AGG).

In an increasingly crowded and competitive marketplace, BlackRock's price-cuts portend further downward pressure on expenses and an intensification of the fee-war, as Issuers vie for market-share by offering the lowest cost products. The repercussions of BlackRock's expense cuts were quickly evident. Charles Schwab, who rapidly rose to the 5^th largest provider in the marketplace with its suite of ultra-low priced ETFs, announced fee cuts on five of its largest ETFs in immediate response to BlackRock. Amid the current challenged investment environment and shifting regulatory landscape, fees will continue to be a key determinant of asset flows.

Looking ahead to the fourth quarter, the contentious U.S. presidential election, beginning of the UK's exit negotiations from the EU, and the waning efficacy of easy monetary policies from global central banks are among several factors that could generate market volatility as 2016 comes to a close.

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