ETFs continue to cut into mutual funds’ share of pie

There was solid growth in the mutual fund market once again last year, and overall its assets far outnumber the comparable exchange-traded fund market. But much like a younger sibling hitting their formative years, the ETF market is gaining ground and growing precipitously — well ahead of mutual funds — and experts expect that trend to continue.

ETF assets under management at the nearly 500 money managers tracked by Pensions & Investments grew 22.5% to $6.6 trillion over the year ended Dec. 31, an annual survey of the largest managers found. For the five-year period ended Dec. 31, ETF AUM was up 168.3%. Over those five years, the seven largest ETF managers — all with more than $100 billion in assets — grew in a range of 112% (State Street Global Advisors) to 400% (Charles Schwab Investment Management).

Mutual fund AUM rose a more modest 10% to $30.47 trillion last year and 40.4% over the five-year period.

"From a vehicle perspective, what you're seeing in U.S. retail in particular is basically a trend away from the mutual fund structure," said Joonsuk Lee, New York-based senior manager at Casey Quirk, a practice within Deloitte Consulting LLP. More of those assets are headed to ETFs and collective investment trusts, he added.

ETFs are attractive because of their intrinsic characteristics: they are simple, transparent and low-cost products to use, said Matthieu Guignard, global head of product development and capital markets at Amundi's ETF, indexing and smart beta unit, in an email. Paris-based Amundi had $99.6 billion in ETF assets as of Dec. 31, a 28.5% rise from the previous year. In April, Amundi announced it had entered exclusive negotiations to acquire Paris-based Lyxor Asset Management in an almost $1 billion deal. Lyxor had $96.9 billion in ETF assets of Dec. 31, a 9.7% year-over-year increase.

The growth in ETF AUM is being led by some of the usual suspects — BlackRock Inc., the largest ETF manager, saw its ETF assets rise 19.2% year-over-year to $2.67 trillion as of Dec. 31, followed by Vanguard Group Inc., which posted a jump of 31.5% to $1.51 trillion, and State Street Global Advisors, which had a 17.9% rise to $905.5 billion.

Vanguard is now in its 20th year as an ETF provider and has gone from offering two ETF products in 2001 to 82 today. As one would expect at Vanguard, its ETF lineup is primarily index ETFs, though it does offer seven active ETF products, including an active bond ETF that launched earlier this year. Vanguard had $453 million in active ETF AUM as of Dec. 31, according to P&I data.

"What we've observed particularly over the last 10 to 12 years is movement by investors from active strategies to index strategies and they are increasingly choosing the ETF as the way they want to index," said Rich Powers, Malvern, Pa.-based head of ETF and mutual fund product management at Vanguard.

That trend has accelerated in the past few years, largely because "a lot of active managers have continued to disappoint from a performance standpoint, and I think investors are saying 'I want to spend less time picking out the best active manager and get a low-cost option and think about asset allocation, and not so much choosing which products are going to be in my portfolio,'" Mr. Powers added.

Mr. Powers said Vanguard offers tax-free ETF conversions for mutual fund clients when there are corresponding ETF shares. "In recent years, we have seen an uptick in volume, particularly with Vanguard ETFs that are priced lower than their mutual fund counterpart," he said.

In the U.S., $500.9 billion flowed into ETFs in 2020, up from $322.5 billion in 2019, according to data from the Investment Company Institute. ETFs saw an additional $248 billion in net inflows in the first quarter of 2021. And while index ETFs dominate the space, flows into active ETFs rose 133% year-over-year in 2020 to $60.7 billion, ICI found. In contrast, index mutual funds saw $100 billion in net outflows in 2020 after $127 billion in net inflows the year before, according to ICI. Net outflows totaled $10 billion in the first quarter.

Mutual funds overall had net inflows of $205 billion in 2020, down from $454 billion in 2019, according to ICI. However, long-term mutual funds had $486 billion in net outflows last year, with money market funds taking in a net $691 billion.

Mr. Lee expects more active managers to launch active ETFs in the coming years because they will say, "'The risk of not being there at all is higher than the incremental carrying costs of launching them.' Whether or not the assets will flow in is much more up in the air."

Investor demand for index-based products has been on the rise in recent years, said Shelly Antoniewicz, senior director of industry and financial analysis at the Investment Company Institute in Washington.

From 2011 through 2020, index domestic equity mutual funds and ETFs received $1.9 trillion in net new cash and reinvested dividends, while actively managed domestic equity mutual funds experienced net outflows of $1.9 trillion, according to ICI. Moreover, index domestic equity ETFs have attracted twice the amount of net inflows of index domestic equity mutual funds from 2011-2020. And in 2019, full-service brokers and fee-based advisers had 21% and 33%, respectively, of their clients' household assets invested in ETFs, up from 6% and 10% in 2011, ICI found.

"Advisers are under pressure by clients to make sure their all-in costs are as low as possible," Ms. Antoniewicz said.

Amundi's Mr. Guignard said pressure on fees is good for investors, "But we believe the search for the lowest cost cannot be an end in itself. Beyond cost, investors want trusted partners that are able to offer long-lasting solutions that fit their needs." Currently, Amundi does not offer any active ETFs, though it continues to assess the space as part of its ongoing product and innovation strategy, he added.

Vanguard's success in the ETF market has led other firms to lower costs, Mr. Powers said. "So not only are people using our products and benefiting, other people are benefiting because of what we've been able to do," he said.

The asset-weighted average expense ratios for index equity ETFs were flat — at 0.18% — and down for equity mutual funds — to 0.50% — year-over-year in 2020, according to ICI data. "Regardless of the vehicle, there's going to be management fee pressure," Mr. Lee said.

The expense ratios for the S&P 500 index ETFs offered by BlackRock and Vanguard are 1 basis point lower than the comparable mutual funds offered by the same managers at 3 basis points each, according to data compiled by Pensions & Investments. Moreover, Fidelity Investments' Magellan ETF has an expense ratio 27 basis points lower than its Magellan mutual fund.

While the ETF market is growing, ETFs are unlikely to enter many defined contribution plan lineups, sources said.

"I think the premise of ETFs with that very liquid intraday trading kind of runs counter to the long-term investment objectives for a future retiree that has a very long investment time horizon," said Greg T. Ungerman, San Francisco-based senior vice president and defined contribution practice leader at Callan LLC.

Also, DC platforms typically hold securities that are valued once a day so adding ETFs would present challenges to record-keeping platforms, said Ross Bremen, partner at NEPC, LLC, in Boston.

ETFs are often available in DC plans that offer brokerage windows, but those brokerage windows "only get a small percentage of plan assets," Mr. Bremen said. "So while ETFs might be increasingly available via brokerage platforms, it's still not moving the needle in terms of assets flowing in that direction."

"ETFs are attractive to retail investors from a fee perspective whereas in DC plans you have institutional buying power; the mutual funds and collective trusts that occupy the DC space are more attractive from a fee perspective than ETFs," Mr. Bremen added.

Though unlikely to broach defined contribution plan lineups, stakeholders are bullish on ETFs, and the possibility for more managers to enter the space.

"If ETFs as a vehicle grow and active ETFs become in vogue, you'll have a similar competition that you see in mutual funds where, yes, there's an advantage to scale and being a big brand, but those aren't the only determining factors," Casey Quirk's Mr. Lee said.