Records continue to be broken by the $8trn Exchange Traded Funds (ETF) industry as it has gotten off to its best start to a year ever with inflows topping $152bn within the first two months. These impressive statistics just continued momentum for an industry that took in a record $502bn in 2020 according to Morningstar Inc, whilst at the same time investors pulled $289bn from open-ended mutual funds. It is the fourth year out of the last six that mutual funds have lost money whilst the ETF industry has never suffered a year of outflows. This ETF growth is more impressive given that a year ago, the market experienced one of the most volatile periods in recent history as the economic impacts of the global shutdown took effect. The resilience of the product structure and supporting capital market infrastructure saw them not only weather the storm but cement their status as the go-to choice for investors to trade during market stress.
ETFs are the preferred investment vehicle for most of the world due to several structural benefits. In addition to diversification there are a few often cited reasons why the global investor prefers investing with ETFs.
The most accepted reason is the low fees. Without teams of analysts and portfolio managers the ETFs naturally have a lower expense ratio. Etf.com estimates that the average US equity mutual fund charges 1.42% in annual expenses, whilst the average equity ETF charges a significantly lower 0.53%, with many of the larger ETFs charging even lower fees than that.
Although cheaper there is no negative impact on performance. Twice a year S&P Dow Jones Indices release their SPIVA scorecard, which is an analysis of the performance of active funds versus the performance of their benchmarks. In the latest report they calculated that three quarters of US active funds underperformed the S&P500. In most instances the greatest reason for underperformance by the active funds is the drag of the higher expense ratios.
ETFs have a significant advantage when it comes to transparency. Most funds only disclose their top ten holdings whereas it is possible to find details of every holding within ETFs down to the smallest instrument. ETFs regularly readjust their holdings to bring their underlying instruments in line with their benchmark indices. Each ETF issuer may differ on the frequency of this but they all have clearly disclosed methodology detailing when they will do this rebalancing. Any adjustment to the portfolio is done so in line with the benchmark.
The final ETF benefit that we want to touch on, was probably the most important during the recent market crash, is that of liquidity. The Bank of England noted this in their Interim Financial Stability Report with specific reference to the US bond market during the crash. They stated, “In light of the relative liquidity in ETF shares compared to the corporate bond market, price discovery was often occurring via ETFs rather than their underlying assets.” ETFs offer liquidity both in the primary market with the ETF issuers and in the secondary market on the exchanges. This ability to trade on an exchange meant that even when the underlying assets were illiquid one could still enter and exit investments.
The global investor has selected ETFs as their default investment vehicle of choice. They have done so based on all the advantages that they offer. ETFs are here to stay, and the growth shows no signs of decline.
Magwitch Offshore is a leading provider of Global Balanced ETF portfolios with products in all major currencies. Magwitch utilise an advisor distribution model and their portfolios are available through offshore endowment structures provided by some of the larger Insurers.
This article was first published in Blue Chip Magazine – edition 79: