The Top 10 ETF and Indexing Stories of 2019
This year put an exclamation point at the end of a decade marked by the ascendance of indexing and ETFs.
The past 10 years have been marked by the ascendance of indexing. At the onset of the decade, index mutual funds and exchange-traded funds held a combined $1.6 trillion of investors' assets. This represented 20% of all money invested in U.S. mutual funds and ETFs. At the end of November 2019, assets in ETFs and index mutual funds had risen to $8.2 trillion, amounting to nearly 41% of total fund assets. Here, I share 10 top stories from a year that put an exclamation point at the end of an eventful decade in the realm of indexing and ETFs.
1. The Year of Zero
2019 was the year of zero in ETFs. It began with the launch of the first zero-fee ETFs and ended with commissions for ETF trades being zeroed out. To the extent that this has resulted in significant cost savings for investors, this is something to celebrate. But there is still work to be done. Fund fees can fall even further, and as they come down, investment costs are creeping into other corners--some of which are dimly lit. In this article, I shine a light on some of those areas.
2. The Sky Is Not Falling
When index funds were first introduced, they were labeled "un-American." ETFs and index funds have since been called far worse: weapons of mass destruction, worse than Marxism, and so on. Underneath the name-calling lie some legitimate concerns, but Alex Bryan argues that most don't hold much water.
3. No One Is Right All the Time
Critics of market-cap-weighted indexing often point to periodic panics and manias as evidence of the pitfalls of relying on the judgment of others to price stocks. Dan Sotiroff contends that the market doesn't have to be consistently right to make the case for investing in funds that track cap-weighted indexes.
4. What's an Index?
According to the Index Industry Association, there are now more than 2.96 million indexes. This figure leaves many breathless and is often used as evidence that indexing has run amok. But indexes are to their constituents as the 10 million colors perceptible to the human eye are to the three primary colors they are made of. Both are a product of the selection and combination of a finite list of ingredients. Far more meaningful is how we've arrived at that 2.96 million number. The 100-plus years it took to get from a single index to nearly 3 million have been marked by significant evolution in the realm of indexing. In this piece, I look at how indexes have evolved and share my thoughts on how they will continue to change and what it means for investors.
5. Not From Concentrate
Many have suggested that the cure for what ails active managers is for them to stop worrying about their benchmarks and build more concentrated portfolios. Alex Bryan studied the performance of concentrated stock portfolios and found that greater concentration isn't a panacea. More concentrated funds tend to charge more than their less concentrated peers, and the spread between top- and bottom-performing concentrated funds tends to be wider, meaning that the risks and rewards associated with manager selection are greater.
6. Don't Fall For a Good Story
During the past decade, the ETF menu was littered with a spread of gimmicky thematic ETFs that spanned from liquor (R.I.P. Spirited Funds/ETFMG Whiskey and Spirits ETF WSKY) to sports sponsors (R.I.P. ProSports Sponsors ETF FANZ). These funds rely on compelling narratives to entice investors. Dan Sotiroff urges you to resist their siren song.
7. A Solution in Search of a Problem
The ETF wrapper can be a more cost- and tax-efficient means of packaging and distributing investment strategies to investors. The problem many asset managers have with the original breed of actively managed ETFs is the requirement to disclose their portfolios on a daily basis. Fretting over whatever secret sauce they may or may not possess, they have looked for alternatives. This year, the SEC approved a number of less-transparent ETF formats that would solve asset managers' problem. However, from an investor's perspective, they aren't--in my opinion--an improvement over fully transparent active ETFs.
8. Keeping the Taxman at Bay
ETFs' tax efficiency is appealing to tax-sensitive investors. As Alex Bryan and I detailed in our latest assessment of funds' tax profiles, ETFs tend to pay fewer and smaller capital gains distributions than mutual funds. This owes chiefly to their structural advantages over traditional open-end funds.
9. An Enhanced Framework for Rating Funds
In November 2016, we began assigning Morningstar Analyst Ratings to ETFs. In 2019, we enhanced our ratings framework, placing greater emphasis on fees and raising the bar for actively managed and strategic-beta funds. Alex Bryan recently sat down with Morningstar's director of personal finance, Christine Benz, to discuss these changes.
10. New Tools for Analyzing Funds
Not only have we enhanced our ratings, we also introduced a number of new tools for investors in 2019. These include a revamped fair value estimate for ETFs and data that allows investors to better understand the geographic footprint of the firms in their funds' portfolios. Most recently, we introduced the Morningstar Factor Profile, which is featured on stock funds' Portfolio pages. The Morningstar Factor Profile is a new lens that complements the Morningstar Style Box, incorporating additional factors that further explain funds' exposures to well-documented sources of long-term returns.
This year, the investment industry lost a legend and investors a fierce ally. Today's investment landscape was shaped by the ingenuity and tenacity of the late Jack Bogle. No one has done more for investors and taken less in return. My colleagues and I paid tribute to him in this video.
Disclosure: Morningstar, Inc. licenses indexes to financial institutions as the tracking indexes for investable products, such as exchange-traded funds, sponsored by the financial institution. The license fee for such use is paid by the sponsoring financial institution based mainly on the total assets of the investable product. Please click here for a list of investable products that track or have tracked a Morningstar index. Neither Morningstar, Inc. nor its investment management division markets, sells, or makes any representations regarding the advisability of investing in any investable product that tracks a Morningstar index.