In case you haven’t heard, exchange-traded funds are gaining ground on mutual funds, in large part because passively managed funds are eating the lunch of active fund managers.
Morningstar said U.S. passive fund strategies in 2016 saw a record $504.8 billion of inflows, exceeding 2014’s record of $422.7 billion. Contrast that to record outflows from actively managed funds of $340.1 billion in 2016, exceeding 2008’s active-fund outflows of $208.4 billion. In February, when the latest data was available, investors put $29 billion into U.S. equity passive funds while pulling out $8.9 billion from active equity funds. February saw the 34th consecutive month of outflows from actively managed U.S. equity funds.
Interest in passive investing benefits ETF issuers such as BlackRock’s iShares unit, Vanguard and State Street Global Advisors, who together hold the vast majority of ETF assets. Todd Rosenbluth, director of mutual and ETF research at CFRA, says these three providers attracted close to 90% of all U.S.-listed ETF inflows in 2016, and together hold 82% of total ETF assets.
Investors’ preference shift has caused some banks and other large financial services firms—such as insurance companies—who offer mutual funds to jump into the ETF market in order to keep up with the times. Specifically, financial heavyweights JP Morgan, Goldman Sachs Asset Management and John Hancock have introduced ETF products during the past few years. These companies see an opportunity to take part in the ETF market’s growth and broaden their appeal to investors.
They may not have a choice, says Tim Clift, chief investment strategist at Envestnet | PMC.
“[They’re] looking at the trend and the flows of money going into ETFs and the lower-cost products. They need to defend their asset base; they can’t ignore it. They have to be participants in it,” he says.
Banks, for example, see smart beta products as their entry. Whether they call it strategic beta or factor investing, a look at their fund offerings show all of them using non-market-cap-weighted investments. Clift says there are two reasons for this.
First, the banks can’t compete with the major ETF issuers on traditional passively managed indexes, and he says banks wouldn’t add value there anyway. They have a better chance to add value by offering smart beta products since that aligns with the academically focused research of many banks.
“They may have an expertise in certain asset classes or a style of investment not currently available in the market,” he says. “I think they have a chance to stand out on the smart beta side because it’s dominated by a lot of small players. Smart beta is crowded, but crowded with smaller players.”
Selling What You Know
A couple of the banks are promoting their in-house proprietary research as a selling point for their ETFs. Bob Deutsch, head of JP Morgan’s ETF business, says his firm’s long history of investment management combined with a proprietary research capability helps it stand out.
“I’d say one of the big differences is we’re not relying on outside index providers or third-party indices. We’re delivering our views on … what we think drives better risk-adjusted returns,” he says.
JP Morgan was one of the earliest of the non-traditional ETF providers to enter the space with its first two funds, the JPMorgan Diversified Return Global Equity ETF (JPGE), which debuted in June 2014, and the JPMorgan Diversified Return International Equity ETF (JPIN), which launched in November 2014.
JPGE has an expense ratio of 38 basis points and assets under management of $71 million. JPIN’s expense ratio is 43 basis points, and it has $672 million in AUM. JPIN is the largest fund, while the JPMorgan Diversified Return U.S. Equity ETF (JPUS) is the second-largest fund in AUM terms, at $259 million.
Overall, JP Morgan had 11 ETFs and $1.43 billion in AUM as of the first quarter.
Mike Crinieri, the global head of ETF strategy for Goldman Sachs Asset Management, says his firm’s ActiveBeta suite of ETFs were based on the strategies the firm has offered its institutional investors in separately managed accounts.