[Editor’s Note: The following originally appeared on FactSet.com. Elisabeth Kashner is director of ETF research and analytics for FactSet.]
Despite the 2020 pandemic, civil unrest and market fluctuations, assets flowed to US-based ETFs at record levels. Investors took an expansive stance as disproportionate flows chased disproportionate performance. ETF investors showed a growing appetite for active management and ESG, which left less space for vanilla and the “smart” beta, covering issuers outside of the big three and asset classes in addition to capital.
But, despite all the expansiveness, parsimony reigned in a key aspect: cost, as customers gravitated towards lower and lower costs, in all segments and strategies. For asset managers, the opportunity increased, but it demanded better performance and sharper margins than ever before.
Expansion axis # 1: registry entries
2020 has brought many types of new highs to the ETF market: record entries, greater interest in fixed income of all time and massive gains for commodities – especially gold.
2020 broke previous years’ records for fixed income ETF tickets, exceeding $ 200 billion. This wave of enthusiasm, fueled by $ 8.77 billion ETF purchases from Federal Reserves, pushed fixed income ETF assets to 20% of the overall US ETF market, from 16% at the end of 2015. While the net equity continued to attract the majority of dollars from ETF investors, the share of shares in ETF flows fell below 50% for the first time. Meanwhile, investors’ appetite for gold, silver and oil has put commodity ETFs back on the map.
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Expansion axis # 2: Pursuing performance
Trend tracking drove much of the flows in 2020, changing the hierarchy in the ETF leaderboards. Cathie Woods’ ARK Innovation ETF (ARKK) reached 13th place in flows, an extraordinary achievement for a fund that ranked 294 in assets under management (AUM) earlier this year. ARKK’s return in 2020 of 152.2% was extraordinary. ARK Investment’s other ETFs also did exceptionally well, bringing the ARK 20 positions on the ETF leaderboards to 12ºlargest ETF issuer.
The Invesco QQQ Trust (QQQ) reached the top 10n inflows for the first time since 2011, attracting $ 16.7 billion while investors were chasing the 48.6% return in QQQ in 2020. The success of QQQ allowed Invesco to maintain its fourth place on the leaderboards and add 0.29% market share, despite anemic flows in the rest of its ETF formation, which collectively lost $ 442 million in net outflows.
The SPDR Gold Trust (GLD) took sixth place in flows in 2020, returning to the top 10 list after a three-year hiatus. GLD ended 2020 with an annual return of 23.7%, but gained 38.4% between March and August 2020. Interest in gold increased the market share of the World Gold Council, sponsor of GLD, by 0.36% . Fascinatingly, among the ETFs offering gold exposure, the GLD lost market share to the World Gold Council’s SPDR Gold MiniShares Trust (GLDM) and the iShares Gold Trust (IAU), which offer identical exposure for a cheaper price.
ETF issuers looking to attract tactical investors have been successful because of their excellent performance. But performance gives, and performance takes. Vendors of “smart beta” that once praised performance above confidence-adjusted risk delivered disappointing results in 2020. Wisdom Tree’s 2.2% weighted average asset returns followed $ 1.4 billion in exits, dropping the issuer took two steps to No. 11. Similar problems plagued the Northern Trust and SS&C as the returns of the Alerian MLP ETFs (AMLP) collapsed in the spring.
Knock-On Effect: Decrease in emitter concentrations
The dominance of the big three in the ETF industry continued, but with significant changes in market share. BlackRock’s $ 120 billion in number 1 entries represented 24.0% of the total, despite BlackRock’s 38.8% initial market share. No. 3 State Street obtained only 3.5% of flows, from an initial market share of 15.2%. No. 2, Vanguard, had more than half the slack, gaining 1.6%. ETF inflows from Vanguard’s stock outperformed all others (Vanguard raised $ 120.1 billion), eclipsing the $ 35 billion runner-up BlackRock. Part of this change may have been driven internally by mutual fund conversions.
Six ETF issuers captured 90% of the 2020 fixed income increase: Vanguard, BlackRock, State Street, First Trust, JP Morgan and Charles Schwab. JP Morgan’s fixed income inflows boosted its rise in the leaderboards.
Expansion axis nº 3: beyond the vanilla
As the Obama administration’s fiduciary rule moves back in history and retail trade accelerates, the realm of pure and simple investment has disappeared somewhat. In 2020, active management took a bite out of vanilla streams, while ESG and other idiosyncratic strategies drilled above its weight at the expense of the once glamorous smart beta.
The level of relative success appears in the flow gap, which measures the difference between the actual and expected share of flows based on the initial percentage of assets within a segment. The graph below shows the gap in 2020 flows by strategy and asset class for equity and fixed income ETFs.
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The idiosyncratic funds, led by the single exchange and ESG, were extremely successful in 2020. ESG flows yielded $ 27.8 billion, or $ 25.8 billion, above expectations. Seventy-four of the 86 ESG funds gained market share, while 11 lost ground and only one closed. The single currency funds did exceptionally well with investors accumulated in QQQ, which only contains shares listed on the Nasdaq exchange.
2020 saw an explosion of new releases and entries for actively managed ETFs. Of the 415 ETFs listed actively managed, 248 gained market share in their specific segments, compared with 120 who lost market share and 23 who closed or switched to passive management. Overall, actively managed ETFs generated $ 56.1 billion, which was $ 21.8 billion more than would be expected based on their initial market share.
This is not the case for most smart beta ETFs. Low volatility, dividends and multifactorial ETFs – the darlings of the mid-decade – led to the poor performance of the smart beta, which earned only $ 35.5 billion. That was $ 38.2 billion less than the initial smart beta market share would have predicted.
Vanilla funds also suffered, led by $ 24.6 billion in exits to the SPDR S&P 500 ETF Trust (SPY).
Despite these expansions – record flows, performance seeking, deconcentration of the issuer and interest in assets and ESG – the ETF industry once again faced a major challenge in the relentless demand from investors for increasingly cheaper rates.
Big contraction: investor demand for low costs
Away from headlines – everywhere and in almost every asset class, strategy and segment – investors demanded more for less, preferring cheaper products. This happened in important spaces, such as Active and ESG, and in more sober strategies and asset classes.
On an asset-weighted basis, the average ETF cost just 0.191% per year in December 2020, compared to 0.197% a year earlier and 0.251% at the end of 2017. The graphs below show the progression divided by asset class and strategy.
Equity, fixed income and commodity ETFs hold 99% of all ETF assets domiciled in the United States. Everyone saw steady declines in the price that investors were willing to pay to maintain them.
As in previous years, ETFs that gained market share cost less than those that lost or closed; the asset-weighted expense ratio for winners was just 0.17%, against 0.20% for losers and 0.66% for funds that closed.
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Equity ETFs face the highest level of competition, with 1,548 on offer as of December 31, 2020. Equity ETFs span around 250 market segments, implementing 27 separate investment strategies. Two-thirds of these strategies saw their weighted average asset expense ratio drop in 2020, and 75% are cheaper than at the end of 2018. For the 13 stock strategies that ended 2020 with AUM of $ 10 billion or more, only two commanded higher prices at the end of 2020 compared to the beginning of the year. The most abrupt price declines occurred in actively managed funds.
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The flows to ESG funds in the “Equity: US Total Market” segment shed light on the dynamics of rates. The graph below shows the flows of 2020 distributed among the 20 funds that compete for dollars from ESG investors in this segment. The preference for cheaper funds – in this case, those that cost between 0.10% and 0.15% per year – is so pronounced that the meager flows to funds that charge more than 0.50% per year are not even noticeable.
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Fixed income ETFs faced the same price pressures, but to a different extent at the strategy level.
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Surprisingly, ESG-oriented bond ETFs have seen a huge increase in preference for low costs, with asset-weighted rates falling from 0.26% in 2019 to 0.18% in 2020.
Conclusion
In short, 2020 brought record ETF flows with expanded opportunity for tactical fund providers, strong interest in active management and a huge increase in demand for ETF ESG, but with greater price sensitivity across all asset classes, segments and strategies. With the new ETF rule reducing entry barriers, we can expect even more fierce competition as investors – retail, consulting and institutional – seek the most efficient vehicles to achieve their strategic and tactical objectives.
At the time of writing, the author did not hold positions in the securities mentioned. Elisabeth Kashner is director of ETF research and analysis at FactSet. Check out Elisabeth Kashner’s e-book, “Discover the key to ETF tax efficiency. “
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