I’m known in the ETF industry as a tough cookie, because I insist on hard data and rigorous proof to back up marketing claims. I’ve dashed the hopes of many who are long on hype but short on delivery. But in March, I let my emotions get the better of me when I fell in love with the fearless girl statue mounted to mark International Women’s Day. I’m the one in blue.
The fearless girl, when she’s not facing down the Wall Street bull, or mugging with some of the founders of Women in ETFs, advertises an ETF: the SPDR SSGA Gender Diversity Index ETF (SHE-US).
ETF investors must have mustered their inner toughness, because very few opened their wallets for SHE-US. SHE’s March $3.2 million in inflows is not enough to keep pace in the hyper-competitive U.S. large cap equity ETF space. Had SHE-US grown assets as fast as the average U.S. large cap ETF, nearly $7.4 million would have flowed in this past month.
And thus unfolds the story of March ETF flows, in which investors spurned stories and art for simplicity, in segments where they had a choice. The winner strategy, again, was boring old broad-based, cap-weighted vanilla, which grew just a wee bit faster than its market share would have suggested, with 1.02 times the expected flows, or about $5 billion over its expected level, given overall March ETF flows.
Not coincidentally, $5 billion is about what strategic funds—sometimes called “smart beta”—would have had to added to their March flows to simply maintain their starting market share.
Active management funds seemed to do better, growing about 1.3 times as fast as their market share would suggest. With about $330 million more in inflows, were flows distributed evenly. Actively managed funds had about $32 billion in AUM at the end of February, making up only 1.16% of the overall U.S. ETF asset base.
Ditto ESG funds, other than SHE-US. ESG, which makes up only 0.09 percent of the U.S. ETF landscape by AUM, brought in about $17.5 million more than expected based on starting size.
But this broad success doesn’t hold up to scrutiny when these strategies’ flows are analyzed in the context of their competitive segments. Most actively managed and ESG funds sit in large, competitive segments, with asset levels well above the U.S. ETF segment average size of $6.4 billion. It takes more to move the needle within a high-asset segment than in an ordinary one.
Most ESG and actively managed funds often do not keep up with the asset gathering in their own segments. To be precise, ESG funds lagged the segment average rate in six out of the eight segments where they are offered. Active funds did better, beating the average rate in 35 segments, but lagging it in 50.
ESG’s results are no better on a dollar basis. ESG funds as a whole saw inflows at only 84% of the rate that their starting market caps would imply. On the whole, these funds are losing ground where it counts: among their direct competitors.
Active vs. Passive
Active did better on a dollar basis, bringing in $1.21 for every dollar expected based on starting segment AUM. In fact, when I first looked at active flows, I thought I saw a turning point. Because a segment-based asset-gathering ratio greater than 1.00 signals a true increase in market share. I thought perhaps March was the month that active management would hit its stride.
But looking deeper what I found wasn’t that encouraging for active management in the broader U.S. ETF context. Active management is doing just fine in segments where there is no real competition from passives, but lagging in competitive segments.
Only 15% of the March flows (about $136 million) went to actively managed ETFs in segments where investors had the choice of both passive and active options. The pace of asset-gathering for these active ETFs fell short of that for passives, at only $0.73 for every dollar expected.
The competitive segments where active management goes head-to-head with passives are large, averaging nearly $155 billion, as actively managed ETFs are fighting alongside giants like SPDR S&P 500 ETF Trust (SPY-US). So far in 2017, actively managed funds in competitive segments are not keeping up with the rapid-fire pace of ETF inflows.
Non-competitive segments tend to be smaller, generally under $1 billion. They also tend to hold hard-to-index securities such as commercial paper and global bank loans. Of the 13 such segments that began March with at least $100 million in AUM, eight grew faster than the ETF market as a whole. However, the global broad-market bond segment, which is home to 13 unconstrained ETF portfolio managers, had a rough month, with outflows dominating the otherwise weak inflows. Active management faced two new challenges there, with solid inflows to a passively managed technical strategy and a newly launched ESG fund.
Still, there are a few segments where active management seemed to be doing well in the face of passive management in March. These competitive segments bucked the trend, and saw actual victories in the form of outsized inflows. MLPs, for example, had a clear success in InfraCap MLP ETF (AMZA-US), with $82.3 million added to its starting March AUM of $262 million. Also impressive, in context at least, was the $5.4 million that bypassed Vanguard FTSE Pacific ETF (VPL-US) to land in First Trust RiverFront Dynamic Asia Pacific (RFAP-US).
All of these are small potatoes during a month that saw $47.7 billion pouring into U.S.-listed ETFs, but they are small victories during an otherwise unimpressive month for active management in competitive ETF segments.
Here’s a summary:
If neither ESG nor active management competed well for U.S. ETF inflows in March, their issuers can at least know that they were in good company. The other brainchild of recent years, strategic ETFs (the so-called “smart beta” funds), had even bigger misses in March. In the table below, a flows ratio of 1.00 indicates that a strategy attracted flows directly in proportion to its starting market share. Higher is better; lower is worse. In March, strategic funds were distinctly unloved.
At the beginning of March, strategic funds made up 21.94% of the U.S. ETF landscape. Yet these funds captured only 10.74 % of March flows. Although some strategies did well, “smart beta” as a whole fought some serious headwinds, including outright redemptions and anemic investor interest.
Among the winners: fundamental, with over $1 billion of inflows, at a flows ratio of 1.16; momentum, with $731 million in inflows, at a flows ratio of 5.43; and two duration management strategies, target duration and duration hedged, which brought in about $73 million each, at flows ratios of 8.52 (duration hedged) and 1.57 (target duration).
These successes were not big enough to overcome the redemptions and weak interest for the rest of the “smart beta” strategies. Nine strategies experienced net outflows totaling over $1 billion, with currency-hedged fundamental, high beta, and optimized commodities hit hardest. The high beta funds lost more than $275 million, or one-quarter of their starting AUM. More strikingly, old stalwarts such as growth, value, and dividends lost ground, as investors piled in money far more slowly than expected, given these strategies’ starting weights. Even newer strategy types like low volatility and multi-factor experienced anemic growth.
The table below ranks the strategic funds by flows-to-starting AUM ratio.
It gets worse. Some strategic funds have no competition within their market segments. Growth, value, and high dividend segments are the classic examples; these edges of the style box have always been strategic – the first factor funds. The same is true for most alternatives and asset allocation funds. Others simply got lucky, with segments to themselves. By definition, strategic funds capture all the flows to these non-competitive segments.
But most strategic funds have to compete for investor dollars with other ETFs in their segments. In March, these funds mostly lost ground, as investors continued to prefer vanilla above all else. Interestingly, strategic funds did well in competitive segments where the other choices were active or idiosyncratic (such as NASDAQ-only IBB-US within U.S. Biotech), but fell by the wayside in segments where vanilla was an option.
Here’s how it went down:
Is the segment competitive?
Segment Flows (in billions)
Strategic Flows (in billions)
Segment starting AUM (in billions)
Strategic starting AUM (in billions)
Strategic Flows vs. Starting AUM Ratio
No Vanilla Option
In segments where investors had a vanilla choice, there was a $2.5 billion net shortfall to strategic funds. That’s real money.
As with active management, there were some bright spots for the so-called smart beta funds, even within highly competitive segments. In the table below, green highlights show strategies that outperformed flows expectations in competitive segments with flows above $1 billion in March 2017 (based on net ETF flows and starting AUM). Standouts include momentum within U.S. small caps and total market, with $61 million to PowerShares DWA SmallCap Momentum Portfolio (DWAS-US), $168 million to iShares Edge MSCI USA Momentum Factor ETF (MTUM-US), and $152 million to PowerShares DWA Momentum Portfolio (PDP-US). Volatility hedged funds did well within developed Europe total market, starting from a tiny base. Currency-hedged dividends within the Japan total market segment also did well, as DXJ-US saw smaller outflows than the segment as a whole, proportionally.
Orange highlights show strategies that may have seen inflows in March, but which fell behind the overall segment pace of asset gathering. Orange also includes funds with zero flows.
Red cells show strategies that lost assets during March.
While strategic funds made progress in certain segments, March has been no kinder to them than it was to ESG or active management. The ETF intelligentsia has had a rough go of it, with many of the new, interesting ideas languishing while plain vanilla continues to gather steam.
Still, I love that statue. That’s got to be worth something.