In her latest report on US ETFs, Elisabeth Kashner writes that in 2021, US fund investors kept on, in high gear.
“Dollars flowed from active to passive management and from pricey offerings to cheaper ones, deepening secular trends. Flows levels, strategy preferences, and fund fees tell the same story,” she says.
ETF flows were the highest ever in 2021, by a huge margin, with mutual funds seeing net outflows of about USD29 billion (per Investment Company Institute estimates as of January 12) while ETFs netted USD942 billion, making it clear that ETFs are the vehicle to watch for US fund trends, Kashner says.
Stock and bond ETFs took in 98 cents of every dollar (net) that flowed into US-domiciled ETFs. Equity ETF inflows drove fund industry growth, rising from USD242 billion in 2020 to USD717 billion in 2021. Equity captured 76 per cent of all US ETF flows, up from 48 per cent in 2020. US fixed-income ETF flows matched their 2020 highs, taking in 22 per cent of net ETF inflows, down from 41 per cent in 2020.
Kashner writes that US fund investors continue to favour passive management. Her findings show that 2021 US ETF flows went to passive vehicles 87 per cent to 13 per cent, a ratio of 7:1. “The overall funds industry ratio is probably even higher, as index mutual funds likely gained assets while their actively managed counterparts probably continued to suffer outflows,” she says.
Thirteen percent is a record high for active management’s share of US ETF flows. Or is it, Kashner asks. Active ETF flows got a boost from mutual-fund-to-ETF conversions, in which asset managers re-wrapped USD37.7 billion. Excluding converted assets, actively managed ETFs drew 9 per cent of US ETF flows in 2021, in line with 2018 and 2019, and below 2020s 11 per cent.
Actively managed ETFs have succeeded in displacing one type of passive management, Kashner notes. Strategic or “smart beta” funds have been losing equity ETF market share to actives. While strategic equity ETF flows of USD140 billion were double (including conversions) or triple (excluding conversions) those of active equity, smart beta equity underperformed expectations.
On January 1, 2021, strategic equity ETFs held USD1.07 trillion, which was 26 per cent of assets under management (AUM) for US-domiciled equity ETFs. By December 31, 2021, strategic equity ETFs had taken in just 19 per cent of all equity ETF flows. She notes that that’s a gap of USD46 billion including conversions, or USD34 billion without.
“Conversely, active equity ETFs over-gathered by USD65 billion (with conversions) or USD27 billion (without)…A few years ago, ETF strategists predicted that smart beta would replace active management. In 2021, the reverse happened. Meanwhile, interest in plain vanilla equity held strong. Excluding conversions, vanilla equity flows were USD5.5 billion, or 0.8 per cent, over expectations.”
Kashner writes that active, non-transparent ETFs (ANTs), “the field of dreams of old-line mutual fund providers” as she describes them, took in about USD4.4 billion in 2021, bringing ANT AUM to USD5.6 billion by December 31. USD4.4 billion, which represents 5 per cent of the flows to active ETFs overall and is a huge haul for a product type that held less than USD1 billion at the end of 2020, she says.
“There’s less interest in ANTs than meets the eye, because of affiliated ownership. The Nuveen Growth Opportunities ETF (NUGO-US) held 59 per cent of all ANT assets at year end. Teachers Advisors LLC owned 99 per cent of NUGO-US as of Nov 30, 2021. Teachers Advisors LLC is a subsidiary of Nuveen LLC, which is a subsidiary of TIAA.
“Unaffiliated ANT AUM amounted to just USD1.75 billion by Sept 30, 2021, the latest date for which 13-F data is currently available.”
Commenting on fees, Kashner writes that ETF strategists have long asserted that investors will pay a premium for specialised exposures.
“Strategists often claimed that, while fees for “dumb beta” would collapse to zero, “differentiated”, i.e., complex or highly targeted exposures, could command higher fees. That turned out to be half right. While the market supports higher management fees in niche asset classes such as commodities, alternatives, and asset allocation funds and in complex strategies like value investing, ESG, and active management, investors have been flocking to lower-cost options across most segments of the ETF landscape. As a result, asset-weighted expense ratios have been falling across asset classes and strategies. No matter the starting point, the destination is the same: 0.00 per cent,” Kashner says.
Fund fees have been falling for years, she comments. “As investors choose lower- or lowest-cost ETFs, and as asset managers respond by competitively trimming ETF price tags, the overall industry expense ratio drops. Over the past four years, the asset-weighted US ETF expense ratio has fallen from 0.23 per cent to 0.18 per cent.
“The goalposts haven’t just shifted. They moved from one end of the field to the other. In December 2017, the asset-weighted average expense ratio for ETFs that had gained market share from their direct competitors was 0.19 per cent, while the losers cost 0.26 per cent. By December 2021, 0.19 per cent was the price tag on market share losers. Successful funds now cost 0.16 per cent.
“The large, broad-based, cap-weighted funds that dominate the ETF landscape weigh heavily in these calculations. But they’re hardly an anomaly. Investors continue to migrate to low-cost options wherever specialized funds compete. Fee wars follow, and then spur more migration. As a result, asset-weighted expense ratios are dropping everywhere.”
Kashner notes that in 2021, the steepest drops in fees were in actively managed equity ETFs.
“In 2017, the handful of asset managers offering actively managed equity ETFs charged 0.89 per cent/year, on average. That was more than five times the cost of comparable vanilla ETFs. By year-end 2021, that price tag had fallen to 0.49 per cent.
“Strategic equity ETFs were affected as well. Value and growth fell from 0.17 per cent to 0.13 per cent, dividend-oriented ETFs dropped from 0.41 per cent to 0.26 per cent, while multi-factor funds shaved down from 0.48 per cent to 0.39 per cent. Idiosyncratic strategies—those using non-standard or non-financial criteria to select and weigh constituents—were in the same boat. Notably, ESG equity ETFs cost 0.38 per cent in 2017, but just 0.19 per cent in 2021. That’s a 50 per cent price drop in a four-year time frame.”
Fixed-income ETFs have been on the same trajectory as equity ETFs, but with some variation, Kashner notes. Bond ETF asset-weighted expense ratios fell overall, particularly for the vanilla and idiosyncratic funds. Yet strategic and active fixed-income ETFs posted slight price increases.
Kashner writes that the pricing power reversal for actives and strategic fixed-income ETFs is largely illusory at the more granular fixed-income category level, where asset-weighted average expense ratios generally fell from 2020 to 2021.
“The highest AUM categories—actively managed broad markets, corporates, bank loans, and strategic corporates—all saw fee compression in 2021. The only significant (meaning AUM of more than USD1 billion) categories where fees rose, on average, were actively managed Treasury Inflation-Protected Securities (TIPS) and strategic (“smart beta”) municipal bonds. The headline strategy-level increases in active bond ETFs were driven by flows to global bank loan ETFs, which are an expensive segment of the bond market. Strategic bond ETF price increases came from an obscure source: acquired fund fees in XMPT-US, an ETF that holds closed-end funds.”
Kashner concludes that as investors save, asset managers face tightening margins that show no sign of slackening.
“Investor preference for passive management and lowest-cost products has become entrenched. As in past years, every basis point mattered in 2021. In the zero-sum fee face-off between investors and asset managers, investors continue to prevail. Asset manager opportunity is plentiful in the ETF landscape, but margins are tighter than ever. Today, the asset-weighted average ETF expense ratio is 0.19 per cent; five years ago it was 0.26 per cent. There’s every reason to expect 0.15 per cent or lower five years hence,” she concludes.