By Elisabeth Kashner, CFA, FactSet
In 2021, US fund investors continued, at top speed. Dollars moved from active to passive management and from expensive offers to cheaper offers, deepening secular trends. Flow levels, strategic preferences and fund fees tell the same story.
ETFs Set US Fund Trends
Exchange-traded fund (ETF) flows were the highest on record in 2021, by a huge margin. Mutual funds had net outflows of around $29 billion (as estimated by the Investment Company Institute as of January 12) while ETFs brought in $942 billion, clearly showing that ETFs are the vehicle to monitor US fund trends.
Stock and bond ETFs absorbed 98 cents of every dollar (net) invested in US-domiciled ETFs. Equity ETF inflows drove fund industry growth from $242 billion in 2020 to $717 billion in 2021. Equities captured 76% of all U.S. ETF inflows, vs. 48% in 2020. 22% of ETF net inflows, vs. 41% in 2020.
Active to passive: one-way flow
US fund investors continue to favor passive management. US ETF flows in 2021 went to passive vehicles 87% vs. 13%, a ratio of 7:1. The overall fund industry ratio is likely even higher, as index mutual funds likely gained assets while their actively managed counterparts likely continued to experience outflows.
Thirteen percent is a record high for the share of active management in US ETF flows. Where is it? Active ETF flows were boosted by mutual fund-to-ETF conversions, in which asset managers repackaged $37.7 billion. Excluding converted assets, actively managed ETFs attracted 9% of US ETF flows in 2021, in line with 2018 and 2019, and below 11% in 2020.
Active vs. Smart Beta
Actively managed ETFs have succeeded in replacing a type of passive management. Strategic or “smart beta” funds lost market share from equity ETFs to assets. While strategic equity ETF flows of $140 billion were double (including conversions) or triple (excluding conversions) those of active stocks, smart beta stocks underperformed expectations.
As of January 1, 2021, strategic equity ETFs held $1.07 trillion, or 26% of assets under management (AUM) for US-domiciled equity ETFs. As of December 31, 2021, strategic equity ETFs had absorbed only 19% of all equity ETF flows. That’s a gap of $46 billion including conversions, or $34 billion without. Conversely, actively managed equity ETFs topped by $65 billion (with conversions) or $27 billion (without). The chart below shows the flow spread for US-domiciled equity ETFs, broken down by investment strategy group.
A few years ago, ETF strategists predicted that smart beta would replace active management. In 2021, the reverse happened. Meanwhile, interest in vanilla common stocks has held steady. Excluding conversions, vanilla stock flows were $5.5 billion, or 0.8%, above expectations.
Who owns ANTs?
Active, non-transparent ETFs (ANT), the dream land of old-school mutual fund providers, brought in around $4.4 billion in 2021, bringing the ANT AUM to $5.6 billion to December 31. $4.4 billion, which represents 5% of flows to active ETFs overall and is a huge gain for a type of product that held less than $1 billion at the end of 2020.
There is less interest in ANTs than it seems, due to affiliate ownership. The Nuveen Growth Opportunities ETF (NUGO-US) held 59% of all ANT assets at year-end. Teachers Advisors LLC owned 99% of NUGO-US as of November 30, 2021. Teachers Advisors LLC is a subsidiary of Nuveen LLC, which is a subsidiary of TIAA.
Unaffiliated ANT AUMs were only $1.75 billion as of September 30, 2021, the latest date for which 13-F data is currently available.
ETF strategists have long argued that investors will pay a premium for niche exposures. Strategists have often claimed that while the fee for “mute beta” would drop to zero, “differentiated” exposures, i.e. complex or highly targeted exposures, could incur higher fees.
It turned out to be half true. As the market supports higher management fees in niche asset classes such as commodities, alternatives and asset allocation funds and in complex strategies such as value investing , ESG and active management, investors flocked to lower-cost options across most ETF segments. countryside. As a result, asset-weighted expense ratios fell across all asset classes and strategies. Regardless of the starting point, the destination is the same: 0.00%.
Fund fees have been falling for years. As investors choose lower-cost or lower-cost ETFs and asset managers respond by competitively slashing ETF prices, the overall expense ratio for the industry plummets. Over the past four years, the expense ratio of US asset-weighted ETFs has fallen from 0.23% to 0.18%.
The goal posts didn’t just move. They moved from one end of the field to the other. In December 2017, the asset-weighted average expense ratio for ETFs that gained market share over their direct competitors was 0.19%, while losers cost 0.26%. In December 2021, 0.19% was the price to pay for market share losers. Successful funds now cost 0.16%.
The large, broad-based, capitalization-weighted funds that dominate the ETF landscape weigh heavily in these calculations. But they are hardly an anomaly. Investors continue to migrate to low-cost options wherever specialty funds compete. Fee wars ensue, then further stimulate migration. As a result, asset-weighted expense ratios are falling everywhere.
Collapse of active ETF fees
In 2021, the largest fee reductions were in actively managed equity ETFs. In 2017, the handful of asset managers offering actively managed equity ETFs charged 0.89%/yr on average. That was more than five times the cost of comparable vanilla ETFs. By the end of 2021, this price had fallen to 0.49%.
Strategic equity ETFs were also affected. Value and growth fell from 0.17% to 0.13%, dividend-focused ETFs fell from 0.41% to 0.26%, while multifactor funds fell from 0.48% to 0.39%. Idiosyncratic strategies – those that use non-standard or non-financial criteria to select and weigh constituents – were in the same boat. Notably, ESG equity ETFs cost 0.38% in 2017, but only 0.19% in 2021. This represents a 50% price drop over a four-year period.
Fixed income ETF Sector preferences Mask Fee pressure
Fixed income ETFs followed the same trajectory as equity ETFs, but with some variations. Bond ETF asset-weighted expense ratios have declined overall, especially for vanilla and idiosyncratic funds. Still, strategic and active bond ETFs posted modest price gains.
The reversal of pricing power for strategic fixed income assets and ETFs is largely illusory at the more granular level of the fixed income category, where average asset-weighted expense ratios have generally fallen by 2020 to 2021. , bank loans and strategic enterprises – all saw fee compression in 2021. The only significant categories (i.e. more than $1 billion in assets under management) where fees increased, on average , were actively managed Treasury Inflation-Protected Securities (TIPS) and strategic (“smart beta”) municipal bonds The main increases in the strategy of active bond ETFs were driven by flows into loan ETFs global banks, which are an expensive segment of the bond market.The price increases in strategic bond ETFs came from an obscure source: acq fund fees. uis in XMPT-US, an ETF that holds closed-end funds.
As investors save, asset managers face a spread squeeze that shows no signs of letting up. Investor preference for passive management and the cheapest products has become established. As in previous years, every basis point counts in 2021. In the zero-sum showdown between investors and asset managers, investors continue to prevail. Asset management opportunities abound in the ETF landscape, but margins are tighter than ever. Today, the average asset-weighted ETF expense ratio is 0.19%; five years ago it was 0.26%. There is every reason to expect 0.15% or less in five years.
Originally published by FactSet on January 25, 2022.
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