ETF growth becomes big plus for index managers

Despite a global pandemic that upended markets early this year, worldwide indexed assets under management rose for the fourth consecutive year, increasing 5.4% to $15.35 trillion on the strength of ETF growth for money managers that participated in Pensions & Investments' annual survey.

U.S. institutional tax-exempt index assets rose to $4.85 trillion as of June 30, a 3.5% increase from $4.69 trillion the previous year.

Worldwide indexed assets managed in exchange-traded funds and exchange-traded notes continued to grow in 2020, rising 11.6% to $4.81 trillion as of June 30. Over the five years ended June 30, passively managed assets in ETFs and ETNs have increased 124.5%, while worldwide indexed assets under management grew 55.5% over the same period.

BlackRock Inc. remained the largest manager of worldwide indexed assets overall, as well as the largest manager of ETFs and ETNs in 2020. BlackRock's ETF/ETN assets rose 13.4% to $2.28 trillion and the firm's worldwide indexed AUM grew 5.1% to $4.73 trillion as of June 30.

"We've seen tremendous growth overall, in ETFs, but what is different, a couple of the trends that are truly remarkable in 2020 are the growth of fixed-income ETFs, and to a great degree, the growth of fixed-income ETFs with institutional investors, both asset managers and asset owners," said Armando Senra, BlackRock's managing director and head of iShares Americas.

Mr. Senra said fixed-income ETFs were "a perfect tool" for portfolio rebalancing and risk management for investors that needed to navigate markets during the period of low liquidity and high volatility caused by the onset of the COVID-19 pandemic.

"For instance, LQD, our investment-grade ETF, on March 12, which was a day of tremendous volatility, changed hands almost 90,000 times on the exchange."

The top five bond holdings in LQD each traded about three dozen times on that date, Mr. Senra said, illustrating the liquidity of the ETF as compared with the bonds.

Worldwide assets managed in domestic fixed income rose 9.4% to $2.17 trillion in 2020. Global and international fixed-income assets rose to $1.23 trillion, a 3.9% increase from one year earlier.

Domestic fixed-income assets managed for U.S. institutional tax-exempt investors remained flat, rising to $783.7 billion in 2020 from $783.5 billion one year earlier. Global and international fixed-income assets rose to $16.9 billion, up from $14.8 billion in 2019, a 14.2% gain.

According to the midyear S&P Indices vs. Active Funds U.S. Scorecard, published by S&P Dow Jones Indices LLC, 97.6% of active long-duration investment-grade funds underperformed their benchmark in the one-year period ended June 30 and 90.1% of active short-duration investment-grade funds underperformed. The Bloomberg Barclays U.S. Government/Credit Bond index returned 10% for the year and the Bloomberg Barclays 1-3 Year Government/Credit index had a one-year return of 4.2% as of June 30.

Institutional investors and advisers were early adopters of ETFs, but Mr. Senra expects ETF assets to increase at an even higher rate now that any doubts about their utility in times of stress have been disproved.

"ETFs have been tested in the past, but there was always a question around, 'what would happen when there's stress in the market?' Our answer was always, we've seen stress in the market during the financial crisis. We've seen stress in the market at the end of 2018. So there were many different points in time where we would highlight how fixed-income ETFs work," Mr. Senra said. "Obviously, this year, March was the ultimate test, and it was clear to all types of investors that fixed-income ETFs provide a very important utility. … We saw that investors replaced bonds for fixed-income ETFs, and they've become a structural part of the portfolio. So what we've seen throughout the year is more adoption, more growth in fixed-income ETFs and more breadth. So while at the beginning of the year you saw a lot of activity in investment-grade or high yield, throughout the year we saw growth in the rest of the product range."

Vanguard Group Inc. was the second-largest manager of worldwide indexed assets on P&I's list, rising 6% to $4.57 trillion as of June 30. Vanguard's ETF and ETN assets grew 15.9% in 2020 to $1.18 trillion. Vanguard has been the second-largest ETF/ETN manager in P&I's universe since 2015.

"This is our best year, from an ETF cash-flow standpoint, by a wide margin," said Rich Powers, Vanguard's Malvern, Pa.-based head of ETF and index product management. "We've received $150 billion of flows this year. Our previous record was around $100 billion and the year's not even done. This is remarkable."

Mr. Powers said the industry is on pace to have the second-largest year of cash flow into ETFs in 2020, and more than half of those assets are flowing into fixed income.

"The reason why that's interesting and important is fixed-income ETFs are only about 20% of the industry's assets. But they're accounting for 50% of the flows," he said. "The organic growth rate there is pretty incredible and continues a trend we've seen the last couple years, where more and more investors are seeing the virtues of fixed-income ETFs and utilizing them in a more significant way in portfolio construction. ... Maybe the best example of this would be why the (Federal Reserve) chose to use fixed-income ETFs in its toolkit to help when the bond market was not functioning as well earlier this year. They did that because they could quickly get access to lots of corporate bonds in a really low-cost way and very efficiently."

The Federal Reserve established the Secondary Market Corporate Credit Facility on March 23 to provide stability and liquidity in the corporate bond market. In addition to buying investment-grade corporate bonds, the Fed also bought U.S.-listed ETFs, "to provide broad exposure to the market for U.S. corporate bonds," according to the Federal Reserve's website.

Mr. Powers said the advantages of index investing — low costs and broad market exposure — have attracted assets into ETFs and he expects this trend to continue.

"The acceptance and preference for indexing, that's at the core of why ETFs have become so popular. We know it's challenging for active managers to outperform. More investors are saying 'I don't want to bear that risk' or 'I want to bear less of that risk so I'm going to invest in an index product,' and an ETF is increasingly the preferred way to do that," Mr. Powers said.

Vanguard is the largest U.S. defined contribution index manager in P&I's universe, with $1.07 trillion in indexed DC assets as of June 30, a 3.3% increase over the previous year. Mutual funds, which account for more than 65% of Vanguard's total indexed assets, rose 2.4% to $2.99 trillion in the year ended June 30. Vanguard has been the largest manager of mutual fund indexed assets since P&I's survey began in 2006.

Mr. Powers said many of Vanguard's index mutual funds and ETFs are share classes of the same fund. "Seventy of our products are structured to have both an ETF and conventional mutual fund share class on the same fund. That has benefits for our ability to track a benchmark well, our ability to create scale in the products, and therefore be able to lower costs. So we are agnostic as to which structure is better for a client. It really depends upon the client's situation," he said.

Some clients, such as defined contribution plans, may be better served by mutual funds that allow systematic deductions and partial share purchases. "With ETFs, the ability to buy partial shares is a relatively new phenomenon, and not really available on many platforms. So we operate in this space where we offer investors options, depending upon their situation, to access indexing in the vehicle that best suits their needs," Mr. Powers said.

By asset class, U.S. equities retained the largest share of worldwide indexed assets, growing 3.6% to $7.22 trillion as of June 30. Global equities increased 8.4% to $1.58 trillion during the one-year period and international equities fell -0.4% to $2.75 trillion.

U.S. equity assets passively managed for U.S. institutional tax-exempt investors rose slightly to $3.06 trillion from $3.04 trillion in 2019. Indexed international equities rose 2.4% to $509.6 billion and global equities rose 10.3% to $355.6 billion.

John Delaney, portfolio manager, delegated investments, at Willis Towers Watson PLC in Philadelphia, said the S&P 500's continued strong performance through 2020 has kept U.S. large-cap index investing a good option for investors and made it a difficult space for active investors to add value.

"There's not a lot of call for, 'Oh, let's go actively manage against this narrowly led index that is tough to beat on an ongoing basis.' Where we've seen more interest in active management, in particular, is in the credit space, where, obviously, whether it's investment grade or high yield, there is an opportunity for managers to add value. The indices are constructed in a way that makes them susceptible to potential outperformance from managers. So we've seen interest there."

According to the midyear S&P Indices vs. Active Funds U.S. Scorecard, 63.2% of active large-cap funds underperformed the S&P 500, which returned 7.4% for the year ended June 30.

State Street Global Advisors, Boston, remained the third-largest manager of worldwide indexed assets, with an 11.6% increase to $2.49 trillion. A 21.2% rise to $842.1 billion in U.S. institutional tax-exempt AUM and 9.9% growth to $732.1 billion in ETF/ETN AUM kept SSGA in third place on those lists, as well.

SSGA's passively managed assets saw double-digit increases in several categories. Indexed AUM in U.S. defined contribution plans grew 41.6% to $312.3 billion in 2020; SSGA was the largest manager of indexed assets for U.S. endowments and foundations, rising 26.2% to $92.1 billion; and indexed assets managed for U.S. defined benefit plans grew 15.4% to $331.7 billion as of June 30.