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One of the more fascinating financial things that I’ve witnessed in recent years is the explosion of exchange traded funds (ETFs). I remember talking to a stock broker friend in the mid-2000s. It was then when he first introduced me to the concept of mutual funds losing clout to ETFs.
I was a fairly new investor. Up until that point, I thought mutual funds were the only option in terms of offering a basket of stocks.
Much later in life, I learned of Vanguard and the Boglehead movement. Anyone reading this who is under 25, feel grateful that you have greater financial information at your fingertips than I did in my 20s.
Even though my friend knew that ETFs were the wave of the future, I don’t think he anticipated how quickly they would gain popularity.
ETFs vs. Mutual Funds
Both ETFs and mutual funds are similar in that both, generally speaking, hold baskets of securities.
The main difference between them is that ETFs can be traded intraday like stocks. In contrast, mutual funds can only be priced and traded at the end of the day.
On top of that, ETFs have been a dominant player within the realm of passive index funds. Passive index funds have been gaining momentum over the years, since John Bogle introduced them in the 1970s.
On the other hand, mutual funds oftentimes have managers who actively try to beat the fund’s benchmark. This is in order to maximize the value back to the customer. However, this usually comes with hefty fees. More times than not, these active managers underperform the benchmark in which they attempt to beat.
A passive fund will oftentimes mimic the performance of an underlying index, such as the S&P 500, by holding the same positions in the index. Since these positions are passive and are not traded constantly, passive index funds typically have lower fees associated with them. The draw of low fees has contributed to the popularity of passive funds over the years.
How Quickly Are ETFs Growing?
Martin Small, the head of U.S. and Canada iShares at BlackRock, in an open letter entitled, “How did we ever live without them”, said
“ETFs aren’t just having a moment. They’re creating a movement.”
Last year, 1 in 4 U.S. investors owned at least one share of an ETF. This year, experts project that the number will rise to 1 in 3 investors.
In the next two years, BlackRock projects that nearly half of all U.S. investors will have at least one position in an ETF.
Who Are the Leaders of ETFs?
The two top ETF asset managers aren’t surprising. According to Morningstar Direct, BlackRock has $1.38 trillion in ETF assets, or almost 40% of the market. Vanguard comes in second place with $872 billion in assets, or roughly 25% of the market.
Total Net Assets
Mutual funds still dwarf ETFs. However, ETFs continue to whittle down the dominant position of mutual funds. As you can see in the chart below, mutual funds account for $16.34 trillion dollars of managed funds, compared to $2.5 trillion in ETFs.
Total Net Assets of Mutual Funds in the US (1998-2016, in trillions)
Total Net Assets of ETFs in the US (2002-2016, in billions)
In 2017 alone, ETFs accounted for $692 billion amount of inflows, while mutual funds hemorrhaged $45 billion in outflows.
While mutual funds had their moment in the sun, it appears that money is now pouring into ETFs. Personally, I have a feeling that as active money managers flame out, only the best money managers will remain.
I foresee that these active money managers will gain an outsized influence, which may start to tip the scales back towards actively-managed funds in the future.
Of course, I don’t know what the future holds. But for now, I plan to keep my funds in passive index funds for the foreseeable future.