Local equity market exchange-traded products have always made up the bulk of funds under management in the category. But there are signs this trend could reverse next year, with growing appetite for strategies that produce income in challenging investment markets.

Kris Walesby, head of ANZ ETFS expects to see more smart beta products next year, particularly in fixed income.

Smart beta products tend not to track a conventional index such as the ASX 200 and instead offer investors a way to express a view about a particular market risk.

Arian Neiron, managing director of VanEck Australia agrees that next year will be a particularly interesting year for the ETF industry in Australia. "We expect a lot more product innovation, particularly new types of smart beta ETFs and exchange-traded managed funds will be launched on the ASX."

He agrees smart beta will be a focus as investors become disillusioned with the poor performance of some active managers.

The latest S&P; Dow Jones SPIVA Scorecard found that the majority of active managers under-performed their respective benchmarks over one, three and five years. This index compares the performance of active managers and their benchmarks

"Investing in smart beta ETFs has risen as active performance has declined. Given this trend, it's likely some active managers who have quantitative divisions will launch smart beta indices that leverage their investment philosophies and processes," says Neiron.

Disruption

"As a result, we expect smart beta ETF investing will continue to disrupt the active management industry in 2017 as performance pressures and factors such as fees become a primary driver for investors," he says.

Globally, says Neiron, smart beta is the fastest growing segment of the investment management industry and Australia is also experiencing this trend. His data shows smart beta ETFs represented approximately 21 per cent of all US ETFs, as at the end of June 2016.

"We expect the number of ETFs on the ASX to increase in 2017, and the majority of new funds will be smart beta strategies or exchange-traded managed funds, that is active managers listing their flagship strategies in an ETMF form," he says.

Lower fees and transparency will be the key drivers of this trend. Says Neiron: "Investors are shifting from active management to smart beta ETFs as they search for outperformance and value in an increasingly cost-conscious world."

Walesby says fixed income ETFs are becoming increasingly popular, making up more than 43 per cent of net new assets this year globally.

"The reason for their growing popularity is that they form a solid yield base with much less volatility than the equity markets. Investing in fixed income ETFs is like providing a loan to a company or government, with an agreed repayment schedule and duration. 

"Australian and global investors are finding them increasingly attractive as the equity markets appear extended and, potentially, more prone to a sell-off," Walesby says.

International ETFs

Jon Howie, head of iShares Australia, says he expects international ETFs to become increasingly popular with local investors next year. 

"The Aussie capital markets only are about 3 per cent of the global landscape of capital markets so there's an enormous opportunity offshore, and ETFs are arguably the easiest way to access those overseas markets," he says.

Alex Vynokur, managing director of BetaShares, notes the local ETF market has grown to more than 100 products, covering asset classes from Australian equities, international equities to commodities, plus many more categories. He agrees investors need to look outside Australia for growth.

"In 2017 there will be a lot more focus on global equities as a source for growth. We have launched a number of products in the global equities space, including in some global growth sectors, such as healthcare, agriculture, cyber security and even global banks, excluding Australia. Global investing and global thematic investing will continue growing," he says.

Vynokur agrees fixed income is an interesting space. "Australians have traditionally under-invested in fixed income. Typically a decision to invest in fixed interest involves comparing the yield to term deposits. With interest rates at 1.5 per cent at the moment, yield from term deposits is not attractive, especially if you look at it from a post-inflation basis. So we certainly expect developments in the fixed income space."

This will provide Australian investors with the ability to further diversify their portfolios and provide another source of income, without just relying on term deposits or holding shares in big four banks.

In the local market Shaun Parkin, head of SPDR ETFs, Australia, says more products that target millennials are hitting the market.

For instance, he says providers such as micro-investing platforms are starting to target first-time investors with ETFs. An example of a micro-investing platform is Acorns, an app that rounds up items you buy digitally and contributes them to an ETF.

Transparency valued

Parkin says transparency and trust are important for millennials and ETFs give investors the ability to see what they are investing in. This makes them attractive to this market.

"Notwithstanding this trend, we anticipate continued appetite for thoughtful, rules-based products that focus on income and global diversification," he says.

Overall, Vynokur says the way investors are using ETFs is changing. BetaShares' research suggests more than 80 per cent of its client base intends to increase their exposure to ETFs.

"The way investors use exchange traded funds is evolving as investors become more informed and confident using them," he says.

In the early days ETFs were used for long-term asset allocation, as the key building blocks for portfolios. Now investors are not only using ETFs to form the core part of their portfolios, they are also adopting them for more tactical purposes.

For instance, Vynokur says they allow investors to be overweight particular countries such as Europe, Japan or the US. They also enable investors to be overweight sectors such as healthcare, for investors who are seeking more defensive exposures, or to the NASDAQ 100 for investors who want growth.

"We're seeing investors start to use some of the more defensive measures such as bear funds, which can help them to protect their portfolios from some of the volatility that has happened recently," he says.

Neiron says other drivers of growth of the ETF industry continue to be the core attributes that they offer investors such as transparency and diversification in an increasingly volatile investing landscape. "Investors are demanding full visibility of their investments and uncorrelated returns to existing asset classes, characteristics that ETFs can offer."

ETFs attract SMSFs

As a result he expects asset managers to increasingly target specific distribution channels such as the growing SMSF sector, which continues to be the fastest adopters of ETFs.

Interestingly, Neiron expects institutional investors to continue to adopt ETFs for purposes such as cash equitisation and increased secondary market trading.

"Institutional investor usage of ETPs in Australia has lagged US and other developed markets but we expect this gap will close in the near future as more ETFs are listed on the ASX and our market matures," he says. 

Neiron says technology could be a future game changer for the ETF industry down the track as providers look for more innovative ways to engage with the consumer and make trades more cost effective and easier.

"It will be interesting to see what happens with blockchain technology and the potential impact to financial services. Robo adviser offerings are also proliferating in Australia, providing automated advice offerings as an alternative. This trend will continue in 2017."