A specialist trader works on the floor of the New York Stock Exchange
Inflows are well below last year’s full-year tally of $935bn but in line to overtake the record before that of $501bn in 2020 © Reuters

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US exchange traded funds have pulled in almost $500bn in new client money this year as investors continue a powerful shift into the vehicles despite a historic pullback in stock and bond markets.

The inflows are well below last year’s full-year tally of $935bn but in line to overtake the record before that of $501bn in 2020, according to data from the Investment Company Institute through October 26. In contrast, long-term US mutual funds — which exclude vehicles that act as alternatives to holding cash — have seen net outflows of $790bn in 2022, far worse than the decline of $59bn last year and $484bn in 2020.

“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,” said Jeffrey O’Connor, head of market structure for the Americas at electronic trading network Liquidnet.

Wall Street’s S&P 500 share index has tumbled 19 per cent in 2022, while a broad Ice Data Services gauge tracking high-grade US bonds has fallen almost 16 per cent.

The inflows into US ETFs this year despite the gloomy backdrop, combined with the fresh pullback in mutual funds, highlights how the move into the asset class represents a fundamental change in how investors allocate capital. ETFs provide investors with the ability to trade funds on the exchanges in a similar way to equities, and typically have lower fees and tax advantages that have made them popular in recent years.

Column chart of US net flows ($bn) showing ETFs in demand even  amid mutual fund exodus

“In just over three years, ETF assets have doubled on persistent net inflows. Even in a down market, with jobs strong, money flows in regardless of the direction of the market,” O’Connor said.

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”.

Ju-Hon Kwek, senior partner at McKinsey, said 2022’s robust performance for ETFs challenged a widely held notion that “ETF growth requires a ‘risk-on’ environment”.

Kwek said the rise of ETFs has occurred in three phases. In the first phase, the format offered a cheap and accessible way to mimic returns of the overall market, competing against more expensive actively managed mutual funds and displacing direct equity holdings.

Next, ETFs moved beyond broad strategies to more complex styles, such as those tracking particular themes or automatically adjusting their holdings based on factors like to price-to-book ratios, leading to a rise in institutional take-up.

A third phase has now begun, in which more managers are launching actively managed ETFs — using a new vehicle for strategies that are very popular in the mutual fund industry. He said these types of funds had “come of age” this year with record levels of product launches and fund conversions.

In particular, Kwek said a “notable pattern” had emerged this year in that outflows from active mutual funds were often followed a few months later by inflows into comparable ETFs.

He pinned this trend on retail investors engaging in “tax loss harvesting” — selling mutual funds while they are underwater to avoid incurring capital gains tax and investing the proceeds in ETFs, which benefit from a more investor-friendly tax regime and, typically, lower fees.

Shelly Antoniewicz, senior director of industry and financial analysis at the ICI, added that the decade-long switch out of actively managed mutual funds was being accelerated by the greater use of ETFs in the model portfolios offered by financial advisers.

She added that with November and December tending to be strong months for ETF inflows as a whole, “if I had to guess, we will exceed 2020”.

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