What a difference a month makes.
In April, I wrote, “At the margins, in small increments, equity ETF investors actively chose active management. That’s new.”
I was pointing out that actively managed ETFs had started breaking out from their niche segments—fixed income, mostly—and were beginning to gain market share in the highly competitive equity space. April’s gains were small. So small that some of my colleagues laughed at me for pointing them out.
Then came May. Actively managed ETFs blew away their competition in the race for asset gathering. Nothing subtle: $656 million of market share gain in competitive equity segments.
But maybe not, because of some tailwinds in May: outflows to big vanilla ETFs that made every other fund and strategy look stronger. I’m talking about you, SPY (SPDR S&P 500 Trust) and your pal IWM (iShares Russell 2000 ETF), with your $4.67 and $4.88 billion in May outflows. Losses like that in a month that saw net inflows to U.S.-domiciled ETFs of $32.83 billion definitely shake things up.
And we haven’t even gotten to cannibalization yet.
In the end, May fund flows left us guessing about the future of active management in the ETF space. Were the big wins really a victory for active management, or were they more a transfer of assets from mutual funds to ETFs — a cannibalization of an existing client base? Will active equity funds continue to gain market share if the big trading vehicles see resumed inflows? Will the cost war start to bite into the actively managed equity space?
Let’s look at the data first.
May Flows By-the-Numbers
Two-thirds of the $656 million in market share gains, $424 million, seeded a single fund, Principal Active Global Dividend Income ETF (GDVD-US). But GDVD had company. Six other actively managed ETFs increased their market shares by $10 million or more, each in a different, competitive equity segment. Here’s the list:
|Ticker||Name||Segment||AUM 4-28-17 ($Millions)||Increase in Market Share ($Millions)|
|GDVD||Principal Active Global Dividend Income ETF||Equity: Global - Total Market||0.0||424.0|
|CCOR||Cambria Core Equity ETF||Equity: U.S. - Large Cap||0.0||100.0|
|AMZA||InfraCap MLP ETF||Equity: U.S. MLPs||368.1||50.7|
|RFDI||First Trust RiverFront Dynamic Developed International||Equity: Developed Markets - Total Market||128.0||35.4|
|SYG||SPDR MFS Systematic Growth Equity ETF||Equity: U.S. - Large Cap Growth||24.2||35.0|
|ARKK||ARK Innovation ETF||Equity: Global - Total Market||20.4||19.1|
|ARKQ||ARK Industrial Innovation ETF||Equity: Global Technology||33.0||18.2|
Keep in mind that, as of the start of May, only five actively managed equity ETFs had assets above $100 million, and only one had managed to cross the $1 billion line: First Trust North American Energy Infrastructure Fund (EMLP-US). The average actively managed equity ETF was far smaller, at $67 million. All the active equity ETFs together were worth just $3.95 billion, or 0.17% of the equity ETF landscape. No doubt about it; $656 million of market share gain for actively managed equity ETFs is a big deal.
May Flows Ignore Two Trends, Intensify Another
It gets bigger. May’s triumph for actively managed equity bucked two industry trends: the dominance of plain vanilla strategies and the slashing of the industry’s weighted average expense ratio. Vanilla funds lost market share in May, after many months of running the table, as readers of my ETF Insight series will recall. Yet the trend to lower expenses continued, especially in segments where funds and strategies compete for investor dollars. Actively managed equity ETFs gained market share despite their higher overall costs.
The cost pressure is intense, with no sign of slackening. Through April of this year, 50% of the net inflows went to just 25 ETFs, with a median expense ratio of .07%. May was no different in terms of a drive to lower costs; funds that gained market share cost only 0.20% on a weighted average basis, while market share losers cost 0.26%. Equity ETFs saw an even wider spread, with market share winners charging a weighted average 0.19% vs. 0.26% for the losers. But it gets more interesting when you sort equity ETFs by strategy.
Here’s a breakdown of costs by strategy in the U.S. Equity ETF space, focusing on segments where strategies compete for investor dollars. By separating funds into two groups—those that gained market share and those that lost it—we can see how investors are making choices. The chart below focuses on the expense ratio, shown as a weighted average by AUM.
|All Equity ETFs||0.19%||0.26%|
While investors in all equity strategies rewarded lower cost funds, those who piled into actively managed equity ETFs were less demanding and tolerated far higher fees than those favoring other strategies. Note that actively managed equity increases in market share went to funds that were only 0.04% cheaper than the competition, while strategic beta investors demanded more: an average of 0.11% cost savings.
Cannibalization a Win?
How did Principal, among others, convince investors to pay up for active management, in a world that’s generally trending to dirt-cheap vanilla?
Principal has an affiliated investor to thank (in other words, an internal client with funds at the ready, according to Paul Kim, Principal’s Managing Director for ETF Strategy). As of June 5, Kim had not commented on whether GDVD cannibalized existing Principal funds. It is possible that GDVD’s success is less of a victory for actively managed ETFs than it is a defeat for the mutual funds or separately managed account structure.
Even the cannibalization explanation begs the question of how active equity ETF investors justified the extra cost, but a bit of context might help. GDVD’s expense ratio of 0.58%, though more than five times expensive as cost-leader Vanguard Total World Stock ETF (VT-US), is the lowest among the actively managed funds in the global total market segment and is also competitive with the segment’s strategic funds, which cost 0.53% on an asset-weighted-average basis. Perhaps it is fair to say that May’s most successful active ETF launch is competing against complex rules-based funds rather than the cheap vanilla strategies. Game on. Cost now matters everywhere, in both the mutual fund and ETF world.
For Once, Vanilla Funds Fall
With the clear drive to lower cost ETFs, it is all the more curious that May’s flows broke the trend of investors favoring vanilla funds. Vanilla ETFs, funds that track a broad-based, representative, cap-weighted index, are generally the cheapest and most efficient of the ETF strategies. Indeed, vanilla funds have been increasing their market share for a few years.
But not in May. May brought a massive headwind to vanilla ETFs, in the form of outflows to SPY and IWM. There was some underperformance in the buy-and-hold funds, too.
While the rotation from high to low-cost vanilla funds continued, some short-term trading vehicles (notably, SPY and IWM) lost not just market share, but actually suffered outflows. Put simply, Vanilla funds as a group will be under pressure any time dollars flow out of SPY-US.
SPY has long been more volatile, flows-wise, than its S&P 500-tracking competitor, showing that each fund has a different user base. Compare IVV and VOO’s steady growth to SPY’s short-term give-and-take as of June 2.