September wasn’t a great month for stocks—the S&P 500 shed 3.8%—but it was just fine for exchange-traded funds (ETFs), which just logged their second-best month for inflows.
ETFs in the US took in a net $35.2 billion last month and are on track to garner $425 billion for the year, which would be topped only by 2017’s record $476 billion, according to etf.com. The inflows came in roughly equal proportions among US equity, international equity, and fixed income, the service indicated.
The inflows come at a time when traditional mutual funds are suffering overall outflows, actually from stock funds, not bond ones.
This ETF trend shows no sign of stopping. Why the popularity? These baskets of stocks, which often track an index, are easily tradeable (as they are listings on exchanges), unlike mutual funds.
Another part of the appeal: ETFs are more tax efficient than mutual funds, which are forced to redeem holdings when an investor sells the funds, thus triggering a capital gains tax that remaining holders must shoulder, often to their surprise and dismay.
The importance of ETFs was explored in a recent forum held by CIO magazine, our 2020 Summit, a four-day virtual gathering. While some traders, such as at hedge funds, use ETFs for rapid-fire transactions, these vehicles regularly end up as stalwarts anchoring portfolios.
With so many ETFs linked to indexes, “the advantage of indexes is that they give you a long-term, thoughtful approach to tracking the market,” said Marina Mets, head of Americas, fixed income and multi-asset product management at FTSE Russell.
“Clients are increasingly holding ETFs on a permanent basis, having been drawn to ETFs given their flexibility initially,” as ETFs are very liquid, pointed out Del Stafford, head of iShares portfolio consulting at BlackRock.
One question that came up at the symposium: What if you needed to buy or sell some stocks—perhaps to rebalance? ETFs can help without going into the underlying stocks, to express market views at that time through a liquidity sleeve. “Then you don’t have to go to redeem or sell individual securities or redeem from alpha strategies,” Stafford said.
One more advantage is also found in fixed income. “There is less risk trading a basket than individual bonds,” said Stephen Laipply, US head of iShares fixed income ETFs at BlackRock. “This narrows the trading costs. And, with ETFs, you don’t have to redeem bonds as you do with a mutual fund.” This is because ETFs trade on an exchange and can be bought and sold among investors without having to create or redeem shares.
His reference was to that practice that is the bane of individual mutual fund investors, the capital gains tax mentioned previously.
Also beneficial are ETFs used to express a theme, allowing investors to follow mega-trends, Stafford said. “Like clean energy, genome, and immunology.”
What’s more, you can even use ETFs to hedge against macroeconomic forces, such as inflation. Stafford noted that investors are taking long positions in Treasury futures as a way to gain inflation break-even, so they only get paid the premium.