ETFs, Mutual Funds Moving in Different Directions

A new report from Cerulli Associates painted a divergent picture of mutual funds and ETFs. While the number of mutual funds is on track to experience its biggest decline in four years, the number of ETFs is poised for just the opposite.

The Cerulli report shows that a net 107 mutual funds disappeared this year through the second quarter as the number of closed or merged funds exceeded the number of new ones brought to market. That’s far more than the net number of mutual funds that vanished in all of 2016, 2017 and 2018, which ranged from 74 to 97.

In contrast, the number of ETFs rose to its highest level since at least 2014. By the end of the second quarter, there were 7,732 mutual funds, the lowest number since at least 2014, and 2,122 ETFs.

Actively managed funds accounted for almost all the net closures of mutual funds. More than 100 mutual funds opened during the first two quarters of the year and almost all were passive index funds.

Cerulli attributes the “rationalization” of mutual funds to the commoditization of the product and to distributors trimming their product platforms. Its survey of asset manager product executives revealed that 33% rate product rationalization a high priority and 58% consider it a moderate priority.

Among the top factors that asset managers consider before closing a fund: assets under management — they want to see “a clear path to getting to the $100 million to $200 million range” — performance and demand from key distribution partners, according to Cerulli.

Fund Asset Flows: Active vs. Passive

Asset flows into actively managed mutual funds were also a net negative. Year-to-date through September they were negative $65 billion, while flows into passive mutual funds rose $148 billion.

ETF flows were a different story. Actively managed ETFs saw inflows of $16.8 billion year to date through the third quarter, while passive ETFs had inflows more than 10 times that large: $184 billion.

“The market share shift toward passive is indicative of investors’ desire to use passive investment to help keep costs low, while still using active where they feel it can provide alpha in less efficient areas of the market,” according to the Cerulli report, referring to both mutual fund and ETF net inflows.

Indeed, the Fidelity 500 Index fund, which has a net expense ratio of 1.5 basis points, led all other mutual funds in net inflows year to date through the third quarter, up $22 billion, topping even flows into Vanguard’s 500 Index Fund, which charges 4 basis points.

The No. 2 fund for inflows was the Fidelity Series Total Market Index Fund, which also charges 1.5 basis points, followed by the Vanguard Total Stock Market Index Funds, whose Admiral shares, requiring a $3,000 minimum, cost four basis points.

In addition to a preference for passive assets, mutual funds and ETFs share another key characteristic: concentration of assets.

The top 10 mutual managers accounted for just over 64% of market share, while the top 10 ETF sponsors had just over 96% of market share.

Although ETFs have been growing steadily in number on a net basis, their assets are far fewer — $4 trillion vs. $15.5 trillion in mutual funds.

Several recent developments could help narrow that gap: the elimination of commissions for ETF trades instituted by Schwab, Fidelity, TD Ameritrade, E-Trade and Ally Financial; the SEC’s new rule that eliminated the need for fund sponsors to seek exemptive relief before bringing new ETFs to market; and the SEC’s approval of a strategy, called ActiveShares, that allows asset managers to build and market non-transparent ETFs (those ETFs are not privy to the exemptive relief change).

An earlier Cerulli survey of “product heads” from 35 asset managers found that 46% indicated they would build nontransparent ETF capabilities within a year if the SEC approved the ActiveShares proposal from Precidian Investments.

ThinkAdvisor.com Senior Writer Bernice Napach can be reached at bnapach@alm.com.