Millennials rush to embrace ETF strategies

Last year US investments into ETFs were larger than flows into index, active mutual and hedge funds combined, data from Bloomberg shows. According to a recent report by consultants EY, global ETFs hold assets of $3.4trn (£2.7trn). That figure is expected to grow to $6trn by the end of 2020, while rival consultant PwC says it will reach $7trn by 2021. 

But as Morningstar notes, it is not just other index funds that are struggling to compete, so too are active managers. Smart beta ETFs are a key area of growth and are expected to account for a quarter of global ETF assets by 2025, according to BlackRock. More than half of investors in a recent survey admitted taking money out of active investments and allocating to smart beta strategies this year. 

Earlier this year analysts at Morningstar termed this tactic “flowmageddon”, where ETFs are consuming an ever greater proportion of fund inflows. 

The 18-35 age group – the largest consumer group in both the US and the UK – are ETFs’ biggest supporters. According to a survey by Legg Mason of more than 5,000 investors, 91 per cent of millennials globally with equity investments use the strategies.

ETFs are far better adapted to the digital age than traditional mutual funds

The study found that while affluent European investors over the age of 40 allocated an average of 60 per cent of their equity exposure to ETFs, for millennials the figure was 86 per cent. In addition, ETFs’ increasing dependence on technology has closely mirrored the coming of age of this generation. 

In fact, research published in October by analysts at Deutsche Bank shows a near-perfect correlation between the number of internet users and ETF assets. Starting from almost nothing in 1995, both have grown to be ubiquitous in the intervening years, hence the move in favour of ETFs won’t diminish even if the performance of active funds improves. 

Consequently, all three phenomena – rising internet use, millennials and ETF investments – are related. Millennials are “digital natives”, for whom online services are an expectation. 

ETFs are far better adapted to the digital age than traditional mutual funds, since while the latter are valued once a day, ETFs are priced and traded throughout market hours. This plays well to the immediacy millennials demand and which online connectivity allows. While a mutual fund can offer static reports and the ability to request to buy or sell when they next trade, ETFs enable investors to see valuations and transact in near real time. 

Mutual funds were well suited to a paper-based world, with period assessments and reliance on advisors. However, ETFs offer a far greater ability to engage a generation looking to manage their investments online, eschewing traditional financial advice. 

The increasing dominance of millennials, technology and ETFs comes together perhaps most perfectly in the emerging market for automated online advice. According to Legg Mason, 80 per cent of UK millennials and 82 per cent in the US say they trust robo-advice. And it should be little surprise that these technology-led solutions rely almost exclusively on ETFs to implement their investment portfolios. 

Overall, the money invested with robo-advisers remains comparatively small, but we should expect it to grow, and it will not just be the fintech start-ups driving the increase; investments in robo-advisers by the likes of BlackRock, Schroders and Aberdeen Asset Management show mainstream buy-in. 

Even if the current model of robo-advice doesn’t end up dominating, whatever does will need to offer a similar degree of online access and engagement for investors. A recent survey by Cap Gemini  found that 40 per cent of high net worth individuals would ditch their wealth manager if it didn’t offer the sufficient online services.

There’s certainly work to be done. While ETFs make real-time information, trading and engagement possible, legacy IT systems and platforms can get in the way. Without platforms that support straight-through processing for ETFs, the benefits of real-time transparency and the pricing certainty of intra-day trading are lost. Without an efficient way to do so, the low costs of the instruments are undermined. ETFs have brought the simplicity and cost-effectiveness of index investing into the digital age. They shouldn’t be hampered by analogue technology. 

Seamless, online trading is not in itself a selling point; it’s merely a prerequisite for the genuinely engaging digital experiences that millennial investors demand. Not every provider with a platform supporting real-time visibility and trading will therefore succeed, but those that don’t offer these facilities will almost certainly fail.

Jerome Gudgeon is head of managed services at JHC