ETFs are eating the US stock market – Financial Times

Exchange traded funds are eating the US stock market. These charts show just how much these passive investing vehicles now dominate trading activity on American exchanges.

Mounting disappointment with the ability of stockpickers to pick stocks that consistently beat the broader market has spurred a momentous shift towards passive investing strategies such as index-tracking funds and, increasingly, ETFs.

Global inflows averaged more than $12,000 a second last year, but because of tax and cost advantages, this trend is particularly advanced in the US — and especially in equities, where it is easier to structure cheap ETFs that accurately track the market.

While outflows from actively-managed mutual funds have hit a cumulative $1.2tn since 2007, overall inflows into index-trackers and ETFs have topped $1.4tn over that period.

While the percentage of US equity trading that is made up of ETFs is still below the pre-crisis peak in value terms, it has steadily picked up since 2014, and it comfortably set a new record in volumes last year.

ETFs now account for about 30 per cent of all US trading by value, and 23 per cent by share volume.

Indeed, in volume terms, seven of the 10 most actively traded securities on US stock markets last year were ETFs, not shares. Bank of America’s stock was the most actively traded security, but it only narrowly pipped SPY, the mammoth $221bn ETF that tracks the S&P 500. After that come ETFs that invest in gold, emerging markets, volatility and banks.

And by value traded, SPY reigned supreme — even beating Apple, the world’s most valuable company. Overall ETF trading volume was up almost 17 per cent last year, according to Credit Suisse, after rising 50 per cent in 2015. The US stock trading volume is only up 7 per cent from 2014.

This is a dramatic shift. In 2013, only three ETFs were in the top 10 most actively traded securities, Credit Suisse notes.

The shift towards ETFs can also be seen on the “primary” side, in data on stock market listings.

While corporate initial public offerings (IPOs) have largely flatlined in the US since the dotcom bust, the number of ETF listings continues to climb at a robust clip, as asset managers unveil a swelling panoply of passive vehicles to ensure they are not rendered obsolete by the passive investing trend.

There are now almost 2,000 ETFs listed on US exchanges, dwarfed by the number of public companies but rising fast, with bourses such as the New York Stock Exchange, Nasdaq and Bats fighting to attract more.

Many asset managers are hopeful that 2017 will prove a turnround year for the active investing industry, as the likelihood of rising interest rates and more market volatility makes it easier to distinguish stockpickers.

But this ignores how cost is also a big driver of ETF flows. While active equity funds have begun to trim their prices to compete better for investors’ bucks — the average expense ratio of US equity funds has fallen from about 99 cents for every $100 invested in 2000 to 68 cents in 2015 — passive funds are also becoming cheaper.

As a result, they still enjoy a yawning expense advantage over the active investing industry, as this chart shows.

If the performance of active asset managers enjoys a renaissance in 2017, the outflows may slow or even reverse. But the long-term trend is likely to remain intact — especially considering that market returns will probably be subdued in the coming years due to already-frothy valuations.

As BCA’s Doug Peta said in a recent note on the burgeoning ETF industry: “If broad returns turn out to be as muted as we expect, every basis point will matter.”

© Bloomberg; AFP

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