2020 ETF Trends: Opportunity Expands, Fees Contract

Despite 2020’s pandemic, civil unrest, and market gyrations, assets flowed into U.S.-domiciled ETFs at record levels. Investors adopted an expansive stance as outsized flows chased outsized performance. 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.

Expansion Axis #1: Record Inflows

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 $200 billion. This surge of enthusiasm, encouraged by the Federal Reserves’ $8.77 billion of ETF purchases, pushed fixed-income ETF assets to 20% of the overall U.S. ETF market, up from 16% 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% for the first time. Meanwhile, investor appetite for gold, silver, and oil put commodity ETFs back on the map.

Expansion Axis #2: Performance Chasing

Trend-following drove much of 2020 flows, shifting the pecking order in ETF league tables. Cathie Woods’ ARK Innovation ETF (ARKK-US) took the #13 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% were extraordinary. ARK Investment’s other ETFs did exceptionally as well, pushing ARK 20 spots up the ETF league tables to the 12^th largest ETF issuer.

QQQ hit the top ten inflows for the first time since 2011, attracting $16.7 billion as investors chased QQQ’s 48.6% 2020 return. QQQ’s success allowed Invesco to retain its #4 slot in the league tables and add .29% of market share despite anemic flows across the rest of their ETF lineup, which collectively lost $442 million in net outflows.

GLD claimed the #6 flows spot in 2020, returning to the top 10 list after a three-year hiatus. GLD ended 2020 with a 23.7% annual return but gained 38.4% between March and August 2020. Interest in gold boosted the market share of the World Gold Council, sponsor of GLD, by 0.36%. 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.

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% returns accompanied $1.4 billion in outflows, dropping the issuer two notches down to #11. Similar problems plagued Northern Trust and SS&C, as Alerian MLP ETFs’ (AMPL-US) returns collapsed in the spring.

Knock-On Effect: Decreased Issuer Concentration

The big three’s dominance of the ETF industry continued, but with significant shake-ups in market share. #1 BlackRock’s $120 billion in inflows comprised 24.0% of the total, despite BlackRock’s starting 38.8% market share. #3 State Street picked up only 3.5% of flows off a 15.2% starting market share. #2 Vanguard picked up more than half the slack gaining 1.6%, Vanguard’s equity ETF inflows dwarfed all others’ (Vanguard raked in $120.1 billion) eclipsing second-place BlackRock’s $35 billion. Some of this shift may have been internally driven by mutual fund conversions.

Six ETF issuers captured 90% 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.

Expansion Axis #3: Beyond Vanilla

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 chart below shows the 2020 flows gap by strategy and asset class for equity and fixed-income ETFs.

The idiosyncratic funds, led by single-exchange and ESG, were wildly successful in 2020. ESG flows netted $27.8 billion, or $25.8 billion above expectations. 74 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.

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 $56.1 billion, which was $21.8 billion more than would have been expected based on their initial market share.

Not so for most smart-beta ETFs. Low volatility, dividend, and multi-factor ETFs—the darlings of the mid-decade—drove the underperformance of smart beta, which brought in only $35.5 billion. This was $38.2 billion less than smart beta’s starting market share would have predicted.

Vanilla funds also suffered led by $24.6 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.

The Big Contraction: Investor Demand for Low Costs

Away from the headlines—everywhere and in nearly every asset class, strategy, and segment—investors demanded more for less, favoring 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 year by December 2020, down from 0.197% one year earlier, and 0.231% at the end of 2017. The charts below show the progression broken down by asset class and by strategy.

Equity, fixed-income, and commodity ETFs hold 99% of all U.S.-domiciled ETF assets. All saw steady drops in the price investors were willing to pay to hold them.

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%, vs 0.20% for losers, and 0.66% 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% are cheaper than they were at the end of 2018. For the 13 equity strategies that ended 2020 with AUM of $10 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.

Flows into ESG funds in the Equity: U.S. Total Market segment shine a light on the fee dynamics. The chart below shows 2020 flows distributed among the 20 funds that compete for ESG investor dollars in this segment. The preference for cheaper funds—in this case, those costing between 0.10% and 0.15% per year—is so pronounced that the meager flows to funds charging over 0.50% 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% in 2019 to 0.18% in 2020.

Conclusion

In short, 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.