Elisabeth Kashner (pictured), FactSet’s director of ETF strategy, writes that despite 2020’s pandemic, civil unrest, and market gyrations, assets flowed into US-domiciled ETFs at record levels.
Investors adopted an expansive stance as outsized flows chased outsized performance, she says. “ETF investors showed a growing appetite for active management and ESG that left less room for vanilla and ‘smart’ beta, embracing issuers outside the big three and asset classes beyond equity.
“But for all the expansiveness, parsimony reigned in one key aspect: cost, as customers gravitated towards ever-lower costs, across all segments and strategies. For asset managers, opportunity increased but required better performance and sharper margins than ever.”
Kashner observes that 2020 brought many types of new highs to the ETF market: record inflows, largest-ever interest in fixed income, and massive gains for commodities – especially gold.
“2020 smashed previous years’ records for fixed-income ETF inflows, breaking through USD200 billion. This surge of enthusiasm, encouraged by the Federal Reserves’ USD8.77 billion of ETF purchases, pushed fixed-income ETF assets to 20 per cent of the overall US ETF market, up from 16 per cent at the end of 2015.
“While equity continued to draw the largest share of ETF investor dollars, stocks’ share of ETF flows dropped below 50 per cent for the first time. Meanwhile, investor appetite for gold, silver, and oil put commodity ETFs back on the map,” Kashner writes.
Trend-following drove much of 2020 flows, shifting the pecking order in ETF league tables, with Kashner documenting that Cathie Woods’ ARK Innovation ETF (ARKK-US) took the No13 flows slot, an extraordinary feat for a fund that ranked 294 in AUM at the start of the year. ARKK’s 2020 returns of 152.2 per cent were extraordinary. ARK Investment’s other ETFs did exceptionally as well, pushing ARK 20 spots up the ETF league tables to the 12th largest ETF issuer.
“QQQ hit the top 10 inflows for the first time since 2011, attracting USD16.7 billion as investors chased QQQ’s 48.6 per cent 2020 return. QQQ’s success allowed Invesco to retain its No4 slot in the league tables and add 0.29 per cent of market share despite anaemic flows across the rest of their ETF lineup, which collectively lost USD442 million in net outflows,” Kashner writes.
GLD claimed the No6 flows spot in 2020, returning to the top 10 list after a three-year hiatus.
“GLD ended 2020 with a 23.7 per cent annual return but gained 38.4 per cent between March and August 2020. Interest in gold boosted the market share of the World Gold Council, sponsor of GLD, by 0.36 per cent. Fascinatingly, among ETFs offering exposure to gold, GLD lost market share to the World Gold Council’s own GLDM and iShares Gold Trust, which offer the identical exposure at a cheaper price point,” Kashner writes.
“ETF issuers looking to attract tactical investors have succeeded by virtue of outstanding performance. But performance giveth, and performance taketh. ‘Smart beta’ purveyors who once confidently touted risk-adjusted outperformance delivered disappointing results in 2020. Wisdom Tree’s asset-weighted average 2.2 per cent returns accompanied USD1.4 billion in outflows, dropping the issuer two notches down to No11. Similar problems plagued Northern Trust and SS&C, as Alerian MLP ETFs’ (AMPL-US) returns collapsed in the spring.”
The knock-on effect of all of this was decreased issuer concentration, Kashner writes.
“The big three’s dominance of the ETF industry continued, but with significant shake-ups in market share. No1 BlackRock’s USD120 billion in inflows comprised 24.0 per cent of the total, despite BlackRock’s starting 38.8 per cent market share. No3 State Street picked up only 3.5 per cent of flows off a 15.2 per cent starting market share. No2 Vanguard picked up more than half the slack gaining 1.6 per cent, Vanguard’s equity ETF inflows dwarfed all others’ (Vanguard raked in USD120.1 billion) eclipsing second-place BlackRock’s USD35 billion. Some of this shift may have been internally driven by mutual fund conversions,” she writes.
Six ETF issuers captured 90 per cent of 2020’s fixed-income surge: Vanguard, BlackRock, State Street, First Trust, JP Morgan, and Charles Schwab. JP Morgan’s fixed-income inflows propelled its rise in the league tables.
Kashner observes that as the Obama administration’s fiduciary rule recedes in history and retail trading accelerates, the dominance of plain vanilla investing has faded somewhat. “In 2020, active management took a bite out of vanilla’s flows, while ESG and other idiosyncratic strategies punched above their weight at the expense of the once-glamorous smart beta. The level of relative success shows up in the flows gap, which measures the difference between the actual and expected share of flows based on the starting percentage of assets within a segment.
“The idiosyncratic funds, led by single exchange and ESG, were wildly successful in 2020. ESG flows netted USD27.8 billion, or USD25.8 billion above expectations. Seventy four of the 86 ESG funds gained market share, while 11 lost ground and only one closed. Single-exchange funds did exceptionally well as investors piled into QQQ, which contains only stocks listed on the NASDAQ exchange.”
Kashner also reports that 2020 saw an explosion of new launches and inflows to actively managed ETFs. “Of the 415 actively-listed ETFs, 248 gained market share within their specific segments compared to 120 that lost market share and 23 that closed or switched to passive management. Overall, actively managed ETFs brought in USD56.1 billion, which was USD21.8 billion more than would have been expected based on their initial market share.
“Not so for most smart beta ETFs. Low volatility, dividends, and multi-factor ETFs—the darlings of the mid-decade—drove the underperformance of smart beta, which brought in only USD35.5 billion. This was USD38.2 billion less than smart beta’s starting market share would have predicted.”
Kashner notes that vanilla funds also suffered led by USD24.6 billion of outflows to SPY-US.
“Despite these expansions—record flows, performance chasing, issuer deconcentration, and interest in active and ESG—the ETF industry once again faced a major challenge in relentless investor demand for ever-cheaper fees,” she writes.
“Away from the headlines—everywhere and in nearly every asset class, strategy, and segment—investors demanded more for less, favouring cheaper products. This was true in hot spaces such as active and ESG, and in more staid strategies and asset classes.
“On an asset-weighted basis, the average ETF cost just 0.191 per cent per year by December 2020, down from 0.197 per cent one year earlier, and 0.231 per cent at the end of 2017.”
She notes that equity, fixed-income, and commodity ETFs hold 99 per cent of all US-domiciled ETF assets. All saw steady drops in the price investors were willing to pay to hold them, she says.
“As in previous years, ETFs that gained market share cost less than those that lost market share or closed; the asset-weighted expense ratio for gainers was just 0.17 per cent, vs 0.20 per cent for losers, and 0.66 per cent for funds that closed.
“Equity ETFs face the highest level of competition with 1548 on offer as of December 31, 2020. Equity ETFs span nearly 250 market segments, deploying 27 separate investment strategies. Two-thirds of these strategies saw their asset-weighted average expense ratio drop in 2020, and 75 per cent are cheaper than they were at the end of 2018. For the 13 equity strategies that ended 2020 with AUM of USD10 billion or more, only two commanded higher prices at the end of 2020 compared to the year’s start. The most precipitous price drops came in actively-managed funds.”
Kashner notes that there is a preference for cheaper funds, costing between 0.10 per cent and 0.15 per cent per year is so pronounced that the meagre flows to funds charging over 0.50 per cent per year are not even discernable.
“Fixed-income ETFs faced the same pricing pressures, but to a different extent at the strategy level. Strikingly, ESG-oriented bond ETFs saw a huge increase in preference for low costs with asset-weighted fees falling from 0.26 per cent in 2019 to 0.18 per cent in 2020,” she notes.
In conclusion, Kashner writes that 2020 brought record ETF flows with expanded opportunity for purveyors of tactical funds, strong interest in active management, and a huge uptick in ESG ETF demand but with increased price sensitivity across all asset classes, segments, and strategies.
“With the new ETF rule lowering barriers to entry, we can expect even fiercer competition as investors—retail, advisory, and institutional—search for the most efficient vehicles to reach their strategic and tactical goals.”