COVID-19 policy moves influence ETF market trends

Trends in exchange-traded fund investing heading into the fourth quarter have largely followed the headlines.

Fixed-income ETFs have gathered more than $140 billion in net flows through Aug. 31 on route to a second straight year of eclipsing equity ETF flows. And strategies incorporating environmental, social, and governance factors have gathered nearly $17 billion since January, 50% more than the prior three years combined.

While interest in these products can largely be attributed to the investor and policy responses to COVID-19, the influence of the pandemic on the ETF market is also traceable to several other trends, some more apparent than others.

"The impact of consumer preference for ever-lower fees is really laying bare those products that are uncompetitive," said Elisabeth Kashner, director of ETF research for FactSet Research Systems Inc.

The "ETF fee war," as many have called it, has been particularly offensive to the largest ETF in the U.S. Though the SPDR S&P 500 ETF Trust remains the market's liquidity stalwart, it has spent several years losing ground to cheaper S&P 500 trackers from Vanguard Group and BlackRock Inc. Since the beginning of 2017, these competing products have both taken in more than $60 billion each at an expense ratio of 0.03%, while SPY has experienced net outflows of nearly $35 billion against a 0.09% expense ratio.

To its credit, SPY still holds $301 billion in assets and its structure as a unit investment trust makes it cleaner for traders to use against futures and options positions, even State Street Global Advisors acknowledged the product's shortfalls. In January, SSGA shifted the index of an existing large-cap ETF to the S&P 500. The product was already priced to match competing S&P 500 products from BlackRock and Vanguard and has since seen $2.3 billion in inflows.

(At a 0.4% expense ratio, the SPDR Gold Shares ETF was on the same path as SPY — losing ground to competing gold products at half the cost or less — until a rally in trading volume helped drive nearly $20 billion into the product this year.)

As the market leaders in ETF assets, BlackRock and Vanguard have benefited tremendously from the ongoing shift to low-fee ETFs. Yet, in 2020, Vanguard, which has an asset-weighted expense ratio of 0.06% across its ETF products, has outpaced the competition in net inflows.

In an analysis that looks at the "fund flows gap" — whether a fund family is seeing fund flows commensurate with its start of year market share — Vanguard, at $113 billion in net inflows through Aug. 31, is $52 billion ahead of its expected flows, according to FactSet's Ms. Kashner, while BlackRock and SSGA are $34 billion and $29 billion behind expectations, respectively.

Cheapness, however, is not a cure-all without brand or distribution. A suite of eight low-cost ETFs from BNY Mellon Investment Management, including core debt and equity funds with ero expense ratios, have seen very little interest since their April launch.

The market's affair with factor funds has also lost its spark.

Among the strategies showing the steepest decline this year are momentum, value, dividend, low-volatility and multifactor products. Including "fundamental" ETFs, such as those based on earnings quality, dividend growth, and balance-sheet strength, these six strategies attracted $209 billion from 2017 to 2019, or 18.8% of net inflows for the U.S. ETF market. This year, these strategies had seen net outflows of $1.5 billion through Aug. 31.

Conversely, the largest gainers in relative flows are ESG funds and simple market-cap weighted products, as well as active ETFs and a small set of ETFs built around Nasdaq-listed securities, including the Invesco QQQ Trust, which serves as a proxy for technology stocks.

The strong flows into active ETFs are bifurcated between debt and equity, and almost wholly unrelated to the introduction of new products that limit portfolio disclosures.

For equities, the five active ETFs seeing the greatest inflows are all managed by ARK Investment Management LLC, whose strategies focus on fast-growing, innovative companies. ARK's five active funds have taken in $6.6 billion in net inflows this year, according to XTF.com, for a total of $13.3 billion in assets under management as of Sept. 11.

On the debt side, flows have gone primarily into active short- and ultra-short-duration fixed-income ETFs, a dual response to sinking yields on money market funds and the relative safety of shorter-dated Treasuries and corporate securities.

The shifting tides of ETF flows

This year, flows into active debt and equity ETF strategies and ESG products have surged while factor funds have taken a step back. Flows are in billions as of Aug. 31.