Revolutionizing the industry for nearly three decades
- Read transcript
Hi, I’m D.J. Tierney, Managing Director and Client Portfolio Strategist supporting Schwab Asset Management.
I’m often asked by advisors about what’s next for ETFs, as this popular investment vehicle continues to evolve in exciting new directions. I thought it would be helpful to review some recent ETF trends, put them into historical context for you, and give you my thoughts about where the category will go next. As an advisor, staying abreast of the changing ETF landscape will help you continue delivering cutting-edge solutions to your clients.
During the pandemic shutdowns last year, individual investors made headlines for piling into so-called meme stocks such as GameStop. There was a palpable and renewed interest in investing last year, which has continued into this year. Younger generations are seeking to put their money to work and are moving markets in ways not experienced in some time. Looking beyond the headlines, however, it wasn’t just individual stocks or Reddit that moved the industry needle, but also ETFs. Launched nearly three decades ago, ETFs continue to dominate retail investor flows in a major way.
As it turns out, ETF flows set a record in 2020. More than $500 billion flowed into US-listed ETFs, which was a 55% increase over 2019, and the trend continued to accelerate this year. Through the first six months, ETFs gathered $473 billion, with $517 billion through the end of July.
Here are the annual flows from the last 25-plus years. Looking at the context of ETF flows from the last few years, including the record 2020 annual flows, and the fact that 2021 has already exceeded it year-to-date.
Considering the record flows and remarkable retail investor interest in ETFs, this is a good time to review the history of ETFs to glean some insight on what drives the category and what may drive it in the years to come.
ETFs have consistently evolved since they first launched 28 years ago, providing investors more choices and improved access to markets. The category has more than doubled in just five years to $6.7 trillion. The category stood at $1.3 trillion a decade ago. ETFs have become a bigger piece of the total retail investment pie. Despite not being featured in most retirement plans such as 401(k)s, ETFs have increased from 11.1% of total open-ended funds a decade ago to 23.2% now.
Since the first ETF was launched in 1993, product innovation and investor appetite has enabled a whole new wave of investing growth. Investors are drawn to ETFs for a host of reasons. Transparency of holdings, most are low cost, intraday liquidity, and efficient access to some difficult-to-access markets. The category’s flexibility has sparked incredible innovation. Asset managers, large and small, have launched a dizzying array of ETFs, which today includes more than 2,500 US-listed products.
From that beginning of the ETF journey in 1993, ETFs initially grew slowly when the industry launched more products seeking to track equity indices primarily, including mid caps, country-specific, and sector-specific ETFs.
The next major ETF event occurred in 2000 when the first factor ETFs were introduced, providing exposure such as growth and value. Advisors and their clients were no longer constrained to investing in market capitalization-weighted indices after factor-based ETFs were introduced.
Next came fixed income or bond ETFs that were launched in 2002. Investors now had the choice to allocate to investment-grade corporate bonds or US treasury bond ETFs in vehicles that trade like stocks.
The first emerging market ETFs were also introduced in 2002 giving investors more asset allocation flexibility.
The first actively managed ETF was launched in 2008, although it took more than a decade for this category to gain traction. The rules, as they existed in 2008, made active a difficult proposition for managers. Active managers were reluctant to launch ETFs, as the hallmark of ETFs at the time, daily portfolio transparency, limited their ability to conceal the proprietary strategies. In other words, active managers couldn’t keep their secret sauce a secret, and the category remained a very small component of ETFs for the next 12 years.
Fast forward to 2020 and the ETF landscape dramatically changed once again. The SEC approved semi-transparent ETFs, which allows fund managers to partially cloak their portfolios, but still allow liquidity providers to create and redeem shares on a daily basis. The new rule paved the way for active managers to launch active ETFs without giving away their secret sauce. This is the most significant ETF event in many years, and it could pave the way for another wave of innovation and further drive flows.
The regulatory developments of 2020, and the new wave of investors in 2020 and 2021 could set the stage for ETF inroads into wealth management to broaden and grow.
As I mentioned at the beginning, we’ve seen a massive wave of new investors enter the market. According to a recent Schwab survey, an amazing 15% of all investors started investing in 2020. We’ve even coined a whole new term, generation investor. Some investors began pursuing single stocks, coined meme stocks, during the pandemic. With education and guidance, however, new investors may soon discover the powerful combination of low-cost diversification and portfolio construction that ETFs allow.
This convergence of new ETF capabilities and new investors sets the stage for a future that could minimize the impressive past. Despite the record flows and growth of ETFs over the last two years, when I look to the future, I can’t help but think regarding ETFs, you ain’t seen nothing yet.