Head of Exchange-Traded Products Nick Cherney discusses the driving forces behind the growth of the exchange-traded fund (ETF) industry and why active ETFs are capturing a larger share of the overall market.

Key Takeaways

  • 2020 was the best year ever for inflows into the U.S. exchange-traded fund (ETF) market, with nearly $500 billion in new assets.
  • Within this overall growth trend, another noteworthy trend is occurring: Active ETF flows in 2020 reached $60 billion and a record number of new active ETFs launched during the year.
  • We expect active and thematic ETFs – which enable financial professionals, institutions and retail investors to create tailored investments – will gain popularity and help the industry continue to attract new assets.

The general consensus on 2020 seems to be that it is a strong contender for the Worst Year Ever. It’s certainly hard to argue with that view on many levels. However, alongside the broader U.S. stock market’s record highs, one growing segment of the market achieved its own high-water mark in 2020: Total inflows in the U.S. exchange-traded fund (ETF) market approached $500 billion, making it the best year ever for new assets being invested in ETFs. Fixed income ETFs were the clear leader, with over $152 billion of net positive flows.1

But inflows alone don’t tell the full story. The U.S. ETF asset base grew by more than $1 trillion for the second consecutive year. The U.S. ETF market is currently the largest and most mature, growing roughly 23% year-over-year in 2020 compared to the 20% growth rate of the global ETF market.2

Furthermore, within this overall growth trend, another noteworthy trend is occurring: Active ETF flows in 2020 reached $60 billion, shattering the 2018 record of $27.4 billion. This is due in part to continued innovation in the space: 167 new active ETFs launched during 2020, another record, accounting for almost half of all new ETFs for the year.3

Why Is the ETF Market Thriving?

The above data show that the ETF industry was indeed one of the few bright spots in 2020. The next logical question, of course, is why was this the case?

As I discussed in a post on ETF usage trends last August, a number of factors have contributed to the growth of the ETF market in recent years. The movement toward fee-only advisory and brokerage services is one reason financial professionals are increasingly gravitating toward ETFs, whose primary advantages over traditional mutual funds are their tax-efficient structure and greater intraday liquidity.

Meanwhile, many retail investors appreciate the fact that ETFs often offer lower costs, more specialized investment options and greater transparency compared to mutual funds. During the COVID-19 correction last March, for example, the transparent nature of ETFs made it easier for investors to see the liquidity constraints of the fixed income markets. So while the most expensive time to sell a position is usually during times of market stress, one benefit of ETFs is that they tend to be more efficient at allocating cost to those who are selling during periods of volatility, rather than to those who stay the course.

Finally, one could make the case that the rise of digitization has led consumers to expect fast, personalized and inexpensive solutions – attributes that are arguably inherent to the structure of exchange-traded investment products.

As for the growth of active ETFs in particular, it is this trend within a trend that is perhaps the most compelling because it speaks to the direction in which the overall market appears to be heading. The fact that ETFs are no longer used solely by financial professionals looking to build passive portfolios indicates that the products are increasingly being viewed as an efficient means of implementing a dynamic asset allocation within active investment strategies.

What Does the Future Hold for ETFs?

Given these trends and the factors that appear to be driving them, where does the ETF industry go from here? Looking ahead to 2021, we think the overall growth trajectory – and especially the rise of active ETFs – looks poised to continue.

As mentioned above, fixed income ETFs remain dominant, but we have seen that dominance begin to shift recently as active, thematic and environmental, social and governance (ESG) ETFs are starting to capture a larger share of total inflows in the U.S. market. Active ETFs performed strongly during 2020, with $60 billion in inflows, while assets in ESG-oriented ETFs saw $23 billion of inflows.4 Furthermore, during the fourth quarter of 2020, two out of every three new dollars were invested in a non-fixed income strategy, whereas the previous three-year average had been roughly one out of every four dollars.

As investors increasingly gravitate toward more transparent and customizable investments, we expect active and thematic ETFs – which enable financial professionals, institutions and retail investors to create tailored investments – will gain popularity and help the industry continue to attract new assets.

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1Bloomberg, as of 12/31/2021.
2Bloomberg, “ETFs' Broadening Reach Sets Stage for Elevated Growth in 2021.” January 5, 2021.
3NYSE, as of 12/31/2001.
4Morningstar, as of 12/31/2020.