The Next Stage of ETF Development

The world of Exchange Traded Funds (ETFs) is maturing and changing. ETF product developers must change with it. The NAOI Dynamic Investments discussed on this site enable them to do just that. In this short blog post I will show how.

The introduction of ETFs to the market is one of the most significant developments in modern investing history. ETFs are essentially mutual funds that trade like stocks with many other advantages. Here are a couple of statistics that show the explosive growth of this simple, easy to work with investment type:

  • According to the Investment Company Institute since 2008, the number of U.S. ETFs has increased from about 700 to over 1600 today, in 2016
  • According to fund data tracker XTF, assets under management by ETFs have almost quadrupled during this time to $2.3 million.

But this growth is slowing and in some cases reversing as the ETF industry ages. XTF reports that 104 ETFs have been delisted in 2016, year to date, because they don’t have sufficient volume to justify their continued expenses.

The Barriers to Traditional ETF Development

As popular as ETFs are, the creation of new ETFs has slowed significantly for several reasons. Among them are the following: 

  • The “Me-Too” Issue –Too many new ETFs are what can be called “me-too” products that must compete with multiple other ETFs tracking the same index. The winning developer in this situation is the company with the biggest marketing budget. It is hard to compete against such ETF giants as BlackRock (iShares), Vanguard and State Street (SPDRs). Me-too ETFs are a dead end for developers.

  • The Exotic ETF Conundrum – As a result of the “me too” issue, new developers must create or discover ever more exotic indexes or trading strategies to track. Thus we end up with ETFs with titles such as: “US Equity High Volatility Put Write Index Fund”. The volume on such exotic ETFs will always be low and expenses high. This is an not an area where ETF developers will make money.

  • The Volatility Trap – A third reason why ETF growth will be stunted going forward is that developers are forced to consider tracking more narrowly focused indexes such as single country stocks (e.g. China) or single commodities (e.g. corn futures). The more narrow the index or goal focus, the more volatile will be the tracking ETF. Such ETFs will have little mass appeal because financial advisors will not find them suitable for the buy-and-hold portfolios that they recommend to their clients. MPT portfolios cannot deal with the downside risk of such ETFs and as a result trading volumes will not support their ongoing expenses resulting in another ETF developer dead end.

The field of ETF development has “hit the wall”. The easy ETFs are already out there and the market for these is dominated by just a few ETF developer giants. Where, then, is the new ETF developer to go to make money in today's market environment?

The Dynamic ETF Solution

To solve this problem and to reinvigorate the field of ETF product development requires a major dose of “outside the box” thinking. Here is where NAOI Dynamic Investments offer a brilliant solution.

Instead of trying to push the limits of creating traditional ETFs, the NAOI sees the future of ETF development coming in the form of combining existing ETFs into the NAOI Dynamic Investment structure as discussed on this site. In the future, developers will create Dynamic ETFs instead of traditional ETFs. And there are an unlimited number of them waiting to be designed - each with significantly better performance and lower risk that virtually any traditional ETF or even MPT portfolio in existence today. 

 The Future of ETF Product Development

NAOI Dynamic Investments are next-generation investments that hold multiple traditional ETFs in what we call a Dynamic ETF Pool (DEP). These are ETF purchase “candidates” for the Dynamic Investment (DI). The DI product will then automatically select the one ETF from the DEP to own based on a periodic sampling of market trends. Only the ETF in the DEP that is trending up most strongly at time of review is purchased and held until the next review.

Dynamic Investments have basically three design elements as listed below. 

  • The ETFs to place in the DEP
  • The review period length (e.g. monthly, quarterly)
  • The trend signal to use

There is plenty of room here for an unlimited number of DI designs - there is no "wall" here to hit as is happening with traditional ETFs. And the developers who create the best Dynamic Investments will have a massive market to sell them to. 

Here is an example Dynamic Investment that the NAOI has designed:

  • The DEP holds TLT (a long term bond ETF) and RZG (a small cap growth ETF)
  • The market sampling period is quarterly
  • The trend signal is the past 90 day % return

We call this the NAOI Core Dynamic Investment. It earned an average of 27% per year during the period from 2007 to the close of 2016! And not one new ETF needed to be created. The design/development work was done by defining the three variables shown above. This is simply one example in a vast new world of ETF Product development.

Summary – The Future of ETF Product Development is Bright!

The future of ETF product development will not be trying to find new indexes to track or defining ever-more exotic ways to trade equities. The future of ETF product development will come in the form of defining new Dynamic Investments by combining existing ETFs in the NAOI Dynamic Investment Structure that you can read about on this at The NAOI has created multiple such Dynamic ETF products and each performs better than any single ETF that it holds in its DEP by a wide margin! The creation of Dynamic ETFs is the path of ETF expansion for the foreseeable future.

Go to this link to read more about how developers can Take ETFs Mainstream.

Education and resources that will assist developers in creating Dynamic ETFs are available as described here.