Bad year for Wall Street hasn’t stopped hundreds of billions in US ETF flows

Expert predicts ETF inflows in the last two months will take this year's inflows past 2020 total

Bad year for Wall Street hasn’t stopped hundreds of billions in US ETF flows

Despite a historic decline in the stock and bond markets, US exchange traded funds have attracted about US$500 billion in new client capital this year as investors continue a strong shift into the vehicles.

According to figures from the Investment Company Institute through October 26, the inflows are significantly lower than the full-year total of US$935 billion last year, but they are still expected to surpass the previous high of US$501 billion in 2020, reported the Financial Times.

In contrast, the year so far has seen net outflows of US$790 billion from long-term US mutual funds – which do not include those used as alternatives to keeping cash – a significant fall from the US$59 billion in 2017 and US$484 billion in 2020.

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“Despite market volatility and a darkening economic outlook, the inflows … are remarkable, with some of the highest profile ETFs seeing sharp acceleration in funds in the face of overwhelming equity weakness,” Jeffrey O’Connor, head of market structure for the Americas at electronic trading network Liquidnet, told the Times.

A comprehensive Ice Data Services gauge that tracks high-grade US bonds has decreased by over 16% in 2022, compared to the 19% decline in the S&P 500 stock index on Wall Street.

Despite the bleak backdrop, US ETF inflows have been strong this year. This, along with the recent fall in mutual funds, shows how the move into the asset class marks a fundamental shift in how investors deploy their wealth.

Since they often offer reduced fees and tax benefits, ETFs have gained popularity in recent years by giving investors the chance to trade funds on exchanges in a manner like shares.

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Todd Rosenbluth, head of research at consultancy VettaFi, added that “it’s a sign that ETFs have become mainstream, and more investors are seeing the benefits despite, or indeed because of, the volatility”.

The strong performance of ETFs in 2022, according to Ju-Hon Kwek, senior partner at McKinsey, called into question the commonly held belief that "ETF development requires a 'risk-on' climate."

Kwek emphasized that this year saw the emergence of a "notable pattern," in which investments into comparable ETFs frequently followed outflows from active mutual funds a few months later.

He attributed this trend to "tax loss harvesting," where retail investors sell mutual funds when they are losing money to avoid paying capital gains tax and investing the proceeds in ETFs, which benefit from a more investor-friendly tax structure and, generally, charge lower fees.

According to Shelly Antoniewicz, senior director of industry and financial analysis at the ICI, the increased usage of ETFs in model portfolios provided by financial advisors is hastening the decade-long transition away from actively managed mutual funds.

Given that November and December typically have high levels of ETF inflows overall, she continued: "If I had to guess, we will exceed 2020."

Read more: ETFs vs mutual funds: what’s the better investment?