The world of ETFs is truly taking off, and last year’s record number of closures is a healthy sign that the industry is focused on quickly pruning strategies that aren’t working out so that it can focus on the growth ahead, David Mazza, ETF strategist at State Street Global Advisors, said in an interview with IndexUniverse.
Product innovation is looking particularly promising in the fixed-income space, where it appears the focus is increasingly on funds cherry-picking interesting niches, such as emerging market credits or particular slivers of credit risk along the ratings spectrum, in favor of broad bond benchmarks, Mazza says.
Last year, financial markets showed signs of healing, surprisingly to the upside, and 2013 is likely to be a bit better in terms of global growth than was 2012, Mazza says. It’s also the year of the 20 th anniversary for SSgA’s SPDR S'P 500 ETF (SPY), the first U.S.-listed ETF and now the world’s biggest. It’s a fitting celebration considering the $132 billion fund that started it all appears to be more relevant than ever.
IndexUniverse:What do ETF investors need to be looking out for in 2013? In broad terms, what are some of the key themes or pressing issues you think should be on investors’ radars?
Mazza: There are a couple components that are important here. First, looking back, 2012 was a year that went surprisingly well for many investors if you think that we started off very bearish on Europe, and with a lot of uncertainties in the marketplace—many of which are still lingering. And what we saw in 2012 was an ample amount of liquidity provided by central banks and by policymakers, which, while it was painful from a volatility standpoint, allowed many investors to get some of those “worst-case scenarios” off the table.
Now, when we think about moving into 2013, we do expect global growth to pick up relative to 2012—to about 3.5 percent, which is an improvement from the 3.1 percent seen last year. We also expect to continue to see divergences around the developed world. The U.S. will grow somewhat robustly, at a relative basis of 2 percent. But even within the eurozone, where we should see “flat-ish” growth of about 0.3 percent, markets like Germany, France and Italy will see big divergences:Germany will grow about 1.2 percent, France will grow about 0.6 percent and Italy will remain in a recession. That’s something investors need to bear in mind:Even in a market we tend to look at in a cohesive way, there will be different dynamics at play on a country level.
We tend to look at the world from a scenario-type perspective, and in that sense, it will be particularly important for investors to keep focused on where opportunities may be from a bull/bear case and base case throughout the year, and more specifically, how they may need to, at the margin, be tweaking their portfolios to take advantage of some of those macroeconomic drivers that are permeating the marketplace.
IU:What types of assets make sense in the uncertain, but slowly growing macroeconomic scenario?
Mazza: We expect a continuation of the more recent market environment we’ve seen over last few months, which means that while you should have exposure to more risky assets within equities and fixed income, you should tilt your portfolio toward return of capital.
In equities, focus on securities that offer not only high yield but that have the ability and cash-flow generation to increase that yield over time and continue to reward you should things turn out more poorly than what you expect. In fixed income, we still have a positive bias toward the corporate space. Clearly there’s significant investor interest within both investment-grade and high-yield corporates; their spreads have come in significantly, but on a relative basis, Treasurys remain fairly attractive.
IU: Is there a particularly interesting asset for investors who are looking for income?
Mazza: An interesting place for investors to focus is on the crossover corporate bond space. It includes the lowest investment-grade bonds, the triple “B’s” and the highest high-yield bonds, the double “B’s.” This is really a sweet spot for corporate fixed-income investing from a potential loss-adjusted yield basis. For those investors concerned with interest rate increases and volatility, it may make sense to focus on the short end of the corporate bond space.
Next year, we could also see increasing investor interest in emerging market local currency bonds for their pickup in yield and increasingly strong balance sheets, as well as the potential uncorrelated currency exposure they can provide.
IU:Where do you stand on gold?
Mazza: Thinking about asset classes outside of equities and fixed income, because of central banks’ willingness to expand balance sheets and continue to engage in quantitative easing, gold will certainly remain a positive. Commodities, real estate, inflation-linked bonds and commodities-linked equities all have the potential to generate a positive real return.
IU:So, should gold be a big theme in 2013, or is the run-up over?
Mazza: At the end of 2012, gold was poised for another positive year, and some investors are questioning whether the more aggressive price targets are realistic, or whether they should be making more conservative assumptions. I would say that whatever your view, gold should play a role in every investor’s portfolio because of its unique nature as an asset class. It has very different drivers of returns relative to equities, fixed income and even commodities. Its supply and demand dynamics are very different.
While you have different demand drivers like jewelry, industrial use and so on, on the supply side, gold output has been stagnant in the last decade, and that will continue to support gold prices. If nothing else, from an asset allocation standpoint, while we may or may not see the strong performance we’ve seen in the past year, gold should remain in a portfolio for the diversification benefits it can offer.
IU:Where do you see the dollar headed? Many are calling for a stronger dollar in 2013. But dollar weakness has been in U.S. investors’ favor for so long that many investors might not be taking full measure of what that could mean for their portfolios. Is that a concern?
Mazza: I agree that it’s a big question mark. It’s one of those opportunities that may or may not materialize. I do feel that a stronger dollar may not be something that some investors are thinking about from a risk standpoint, so understanding what impact the dollar could have on a portfolio is extremely important. This is one of the reasons why in 2012 gold remained supported—because many investors find it difficult to understand all the different drivers behind currencies, but precious metals—gold in particular—may make sense from a currency allocation perspective.
Mazza (cont'd.): Currency has not been something that many investors have traditionally focused on in the U.S., but our clients in Europe, for example, have started to take a particular interest in understanding where their currency exposure is coming from.
IU:Looking at the ETF industry for a second, what do you make of the different cross currents we’ve seen in 2012:record ETF closures, decelerating launches, and assets at record levels, while many investors are said to be on the sidelines. Where do we sit today, and where are we headed?
Mazza: No doubt that 2012 was an interesting year for ETFs, because we continued to see launches that were unique products focused on unique asset classes. We also saw a significant amount of closures, which had people wondering what it all means for the future.
In an industry that continues to see the amount of inflows that it has, the closures are a sign of health in the long run, because sponsors are focusing on products that show growth potential; products that may be unique in orientation such as advanced indexing—those outside of traditional market-cap-weighted strategies—or actively managed or solutions-oriented.
Going forward, I have to say that education will remain paramount, as it has been in our SPDR ETF effort. But aside from that, I think the fixed-income space will continue to see a lot of growth from a fund launch perspective. We are moving away from the more aggregate multisector fixed-income approaches to more tailored building blocks. I think 2013 will be a year where active management will also pick up some pace as investors better understand these products.
IU:As we talk about the next phase of the ETF industry, let’s talk about SPY. It’s coming up on its 20 th anniversary this month. How do you see SPY’s relevance today—20 years later—given how investor needs have evolved?
Mazza: It’s very exciting to see an ETF launched in January 1993 continue to be of paramount interest and importance from a global capital markets perspective. SPY’s liquidity and leadership are really quite strong, and interest in this fund continues to grow. The idea that SPY spawned a broader industry that has—through thick and thin—shown it can offer investors the benefits of liquidity, transparency, improved access and cost-efficiency is very exciting.
Going forward, SPY has proven that it will continue to be the vehicle of choice for investors of all kinds.
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