“It is the mark of an educated mind to be able to entertain a thought without accepting it.” ― Aristotle
It’s Blogger Wisdom week here on Abnormal Returns. As we have done in previous editions we asked an esteemed group of finance bloggers a series of (hopefully) provocative questions. The answers are not edited and the author’s name, blog name and Twitter handles follow. Yesterday’s post looked at some of the funny things we do with money. We hope you enjoy these posts as much as we do putting them together.
Question: As of the end of August 2017, the ICI reports that long-term (x-money market funds) mutual funds hold $15.106 trillion in AUM and ETFs hold $3.067 trillion in AUM. When, if ever, will they crossover?* (Answers in no particular order.)
It will happen, eventually…but we’re still a long, long way away. More than a decade.
I would expect them to crossover as the baby boomer generation dies off and the next generation of savers/investors, who grew up in the online world of robo-advisers, matures and contemplates retirement. Within 20 years.
Not in the next ten years. While mutual funds versus ETFs is somewhat of a proxy for active versus passive management, they are two different things. Passive will keep growing, but some of that will be in mutual fund structures. Also, I would expect disappointments in ETF-land, including some liquidity problems during times of stress (leading to bigger price/NAV disparities) and weak performance from some of the “ETF strategist” platforms that have emerged.
Exchange-traded fund assets are still a small fraction of overall open ended mutual fund assets, but the gap is slowly closing. In my opinion, we are still years (if not decades) away from ETFs overtaking traditional mutual funds and one of the largest hurdles may be retirement plans. Mutual funds have an advantage in that they are virtually the only option in traditional 401k and 403b plan. They are also prevalent in many variable annuities as well. If ETFs can cross that threshold, they will receive a strong boost in steady fund flows that continue to grow the overall asset base.
It won’t cross over, ever. Eventually people will realize how much gets eaten up of the returns of ETFs from creating and liquidating units, and they will realize that open-end funds are better. (In order to get to this point of view, you must look at the returns on a dollar-weighted basis.)
Ben Carlson, A Wealth of Common Sense, @awealthofcs, author of Organizational Alpha: How to Add Value in Institutional Asset Management:
Using data from ICI, it looks like ETFs have been growing at 20% year over year for the past 5 years while mutual funds have grown at 7% annually. If that pace were to continue it would take around 15 years or so for ETFs to eclipse mutual funds. Obviously, the past 5 years have seen large market gains as well so I’m not sure this type of growth can continue for either group. But I’ll assume ETF growth will continue to be higher than mutual fund growth in terms of net flows so I would take the under on 15 years and say it happen sooner. And the only reason it won’t happen sooner is because ETFs haven’t infiltrated 401k plans yet. If and when that happens, this trend will accelerate.
Tobias Carlisle, The Acquirer’s Multiple, @greenbackd, co-author of Concentrated Investing: Strategies of the World’s Greatest Concentrated Investors:
ETFs get mutual funds within 20 years. The only thing propping up mutual funds is money people forgot they had and the Byzantine rules for extracting it. Once managers and investors discover good discretionary ETFs it’s over completely for mutual funds.
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I am not sure they will cross-over until retirement plans allow or adopt ETFs as an investment vehicle.
ETFs are simply one wrapper to access risk assets. The total in risk assets dwarfs the assets in risk assets. The only visibility for ETF AUM to exceed money market AUM would be at the expense of traditional mutual funds and so sure, that could happen at some point.
The triumph of indexing is inevitable, but the triumph of indexing via exchange-traded funds isn’t. It could be that the ease of trading ETFs proves their undoing in a market decline. It could be that an entirely new way to index emerges. It could be that actively managed mutual funds, faced with the prospect of a slow death, find ways to co-opt elements of indexing to stem the outflow of assets.
By the time you finish reading this sentence. Or 2025. Whichever comes first.
I definitely think it’s a matter of when and not if and is largely dependent on the 401k-space. Mutual funds have the lion share of the market for qualified plans, so we need to see more 401k providers offering more ETFs options in order for mutual funds to begin playing second fiddle in assets to exchange traded products.
So long as 401k plans remain the dominant investment vehicle for most Americans — and so long as most 401k plans are limited to investing in mutual funds — I don’t see that crossover happening.
So much depends on how companies structure their 401(k)s. That’s a lot of mutual fund money, and workers don’t have a lot of options to go a different route. This is a chronically overlooked part of investing: How much money — trillions of dollars — comes from employee retirement plans with limited options. A lot of those options aren’t very good, either.
I wish it would happen tomorrow, but the mutual fund industry is so embedded in the structure of the financial system that it’s hard to see this changing that fast. I’ve long referred to mutual funds as “dinosaurs”, but the dinosaurs lived a long time. Given how entrenched these dinosaurs are in places like the 401K market it’s hard to see things changing as fast as they should be.
Possibly in 20-30 years. I don’t underestimate the massive resources of the securities industry and their allies, the financial media. They will continue to obfuscate the issues and confuse investors. It should have happened by now. Despite recent progress, we have a long way to go.
I think the cross-over will occur when ETFs see further adoption in retirement plans. In this space, tax efficiency is less of a selling point, so there remains an education hurdle in getting participants to understand what an ETF is and why they might choose the structure over a mutual fund. There are also operational burdens here as well: by trading intraday, ETFs would require updates to retirement record-keeping systems. I believe that as soon as these headwinds are overcome and we see broader adoption of ETFs in retirement plans, ETFs will more rapidly overtake mutual funds.
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Wesley R. Gray, Ph.D., Alpha Architect, @alphaarchitect, co-author of Quantitative Momentum: A Practitioner’s Guide to Building a Momentum-Based Stock Selection System:
I don’t know. Maybe Jim Rogers has a guess?
In the next 10 years. Passive investors should and will minimize the fees they pay.
If mutual funds lack the tailwind of market appreciation that has made up for the headwind of outflows over the past 10 years (my expectation) and/or if ETFs figure out how to guarantee an end-of-day NAV that will allow them to capture more of the retirement market, they may crossover within the next 10 years. On the other hand, if mutual fund managers are able to successfully lobby for similar tax treatment as ETFs (i.e. taxable only to an investor when sell) and they can clean out all the fees intermediaries currently charge, I can see it taking much longer / never happening given intraday trading lacks any real benefit for long term investors.
I think the crossover is unlikely, but not impossible. Two things that could speed up this process would be faster settlement for ETF trades (it currently takes two days versus one day for mutual fund trades) and broader use of ETFs in retirement plans.
Sooner than we think. 2020? It will be faster if there is a crash, as more high-fee active funds will see outflows.
ETFs are great — passively managed ones, of course. But, other than intra-day trading (which is irrelevant for long-term investors anyway), they don’t really offer very much over and above a conventional index fund. There’s definitely scope for ETFs to grow much further, but I’m not certain they’ll ever overtake mutual funds.
I find it ironic that many who would not make any forecast based upon analysis of past data are willing to extrapolate this trend. The trend will change when we have a significant downturn in stocks. That is probably before the crossover.
When the S&P tops. I actually don’t think they will ever cross over.
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When the Wu-Tang Clan’s Ghostface Killah ETF (Ticker: KILL) becomes the largest investment vehicle in history, circa 2022.
Who knows. But I hope never, because most investors don’t need to be able to buy and sell portfolios of stocks or other assets on a tick-by-tick basis. The ability to act creates the reality of acting. I’d ask when longer-term interval funds will eclipse short-term liquidity vehicles and thus hedge impulsive decision-making. I’d bet a lot of money on “never” for that to happen.
There’s a generational shift in investing. Millenials are not buying mutual funds so it will naturally crossover in time. But it will take a long time because the incentive structure inside the Mutual Fund industry is quite strong. The industry has powerful momentum and an army of salespeople. Mutual Funds may not be the best deal for investors, but as an industry and a business case, it’s still very impressive.
Thanks to everyone for their time and effort. Stay tuned for a new Blogger Wisdom question tomorrow.