ETFs could seize half of current US mutual fund assets, says Citi (2024)

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The rapidly growing exchange traded funds industry could seize half of the money currently held by long-term US mutual funds in the coming decade, according to estimates by Citi.

US investors have gradually been switching from mutual funds to ETFs for at least the past decade, attracted by lower costs, better liquidity and greater tax efficiency. Mutual funds, excluding money market funds, have seen net outflows in nine of the past 10 years in the US, according to data from the Investment Company Institute, even as ETFs have seen constant inflows.

Despite this, however, the mutual fund industry remains far larger, with $19.6tn in long-term funds at the end of 2023, according to the ICI, dwarfing the $8.1tn in US-listed ETFs.

This could reverse in the coming decade, though, according to Citi, which believes $6tn to $10tn of the remaining money in long-term mutual funds is at risk of capture by ETFs.

“The US asset management industry is clearly in an ongoing paradigm shift,” said Scott Chronert, global head of ETF research at Citi. “The flow trends speak for themselves.

“All told, we project that an additional $6tn to $10tn in mutual fund AUM is at potential risk of ETF replacement or cannibalisation,” he added.

ETFs could seize half of current US mutual fund assets, says Citi (1)

Most vulnerable to predation are mutual funds held outside of tax-exempt retirement accounts, which are unable to compete with the ability of many ETFs to defer capital gains tax liabilities that accumulate within a fund.

Citi estimates that between half and all of the $2.4tn currently held by retail investors in non tax-exempt mutual funds is a potential target for replacement by ETFs.

In addition, between a quarter and a half of the $4.1tn of equivalent money held by institutional investors, and up to a fifth of the $1.3tn non-taxable variable annuity market is also up for grabs.

ETFs could seize half of current US mutual fund assets, says Citi (2)

Chronert pointed to the rising use of model portfolios, which are typically built using ETFs, as a key factor driving this trend.

The $11.9tn worth of mutual funds held within tax-exempt retirement structures, such as 401k defined contribution schemes and individual retirement accounts, are likely to prove stickier, as ETFs do not have any tax advantage here.

Nevertheless, Citi argued that there were a number of trends in place that would allow ETFs to chip away at mutual funds’ dominance in this arena.

ETFs could seize half of current US mutual fund assets, says Citi (3)

Firstly, IRAs are accounting for a rising share of US retirement assets, having risen from below 20 per cent in 1995 to around 35 per cent now.

This is relevant because while “historically, ETFs have not had a place on the 401k menu”, IRAs “are typically much more open architecture in nature than a set menu of funds” meaning that ETFs “certainly have a large, and growing, opportunity here”, Chronert said.

Mutual funds’ share of IRA assets has already fallen by about 10 percentage points to 40-45 per cent since 2005, Citi found.

Secondly, even within 401ks, more schemes are now offering a self-directed brokerage option, allowing savers to access a much wider range of investments. ETFs now account for 23 per cent of self-directed assets, up from 12 per cent a decade ago.

Other opportunities abound. The vast majority of 401k savers aged under 35 simply invest in a target-date fund, designed to adopt a level of risk appropriate for their age. Research by FactSet suggests many of these target-date funds in turn use ETFs to manage this glide path.

Finally, Citi believes demographics will play a part as younger generations — which exhibit clearer preferences for ETFs — build assets.

Tying this together, Citi estimates that 50-60 per cent of the $7.4tn held by retail investors in retirement accounts could be seized by ETFs, along with a small slice of the $4.5tn of institutional and variable annuity rate money.

Combined with its estimates for non tax-exempt investments, this would mean $6.3tn to $10tn of the $19.6tn currently held by US-domiciled mutual funds is a potential target for ETFs.

Others saw things a little differently, though.

Bryan Armour, director of passive strategies research, North America at Morningstar, noted that during 2022 and 2023 “something like $1.6tn flowed out of mutual funds and a big chunk of that went to ETFs”, adding “I don’t know that there’s a natural point where [that flow] stops”.

However, Armour believed mutual funds had some advantages over ETFs, such as the ability to close to new investors if a fund gets too large. He also saw use cases for assets such as private credit, which mutual funds can hold but ETFs cannot.

“The 800lb gorilla in the room,” Armour said, is the chance that the Securities and Exchange Commission could approve the many applications by asset managers to copy the “ETF as a share class” structure that has helped propel Vanguard’s rapid expansion, the patent for which has now expired.

Gaining approval would potentially render the relevant pre-existing mutual funds more tax efficient, softening the pressure for investors to flee to an ETF.

However, when it comes to retirement plans, Armour believed mutual funds are “more under attack from collective investment trusts than they are from ETFs”.

CITs, which account for 38 per cent of 401k assets, according to the ICI and BrightScope, “are cheaper to run [than mutual funds] and they can have variable fees [meaning] they can negotiate fees lower for bigger plans”, Armour said.

Research house Cerulli Associates agreed with Armour on this, arguing that the growing adoption of CITs in the DC market “has raised questions about whether mutual funds are heading towards obsolescence.

“CITs have gained market share and are overtaking mutual funds in 401ks,” said Adam Barnett, senior analyst at Cerulli. “CITs, on aggregate, have far lower management fees than mutual funds of a similar composition.”

ETFs could seize half of current US mutual fund assets, says Citi (2024)

FAQs

What are three disadvantages to owning an ETF over a mutual fund? ›

Disadvantages of ETFs
  • Trading fees. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ...
  • Operating expenses. ...
  • Low trading volume. ...
  • Tracking errors. ...
  • The possibility of less diversification. ...
  • Hidden risks. ...
  • Lack of liquidity. ...
  • Capital gains distributions.

Is it better to hold mutual funds or ETFs? ›

The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.

Should I convert all my mutual funds to ETFs? ›

If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.

What happens if ETF shuts down? ›

ETFs may close due to lack of investor interest or poor returns. For investors, the easiest way to exit an ETF investment is to sell it on the open market. Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF.

Which is riskier ETF or mutual fund? ›

The short answer is that it depends on the specific ETF or mutual fund in question. In general, ETFs can be more risky than mutual funds because they are traded on stock exchanges.

Why would anyone buy mutual funds over ETFs? ›

In addition to phone support from knowledgeable personnel, mutual funds may offer check-writing options and other shareholder services that ETFs don't provide. Dividend reinvestment plans (DRIPs) take the stress of decision-making by automatically converting dividend distributions into investment growth.

Which is better for long-term use ETF or mutual fund? ›

In many ways mutual funds and ETFs do the same thing, so the better long-term choice depends a lot on what the fund is actually invested in (the types of stocks and bonds, for example). For instance, mutual funds and ETFs based on the S&P 500 index are largely going to perform the same for you.

What is the best ETF to buy right now? ›

Top sector ETFs
Fund (ticker)YTD performanceExpense ratio
Vanguard Information Technology ETF (VGT)10.8 percent0.10 percent
Financial Select Sector SPDR Fund (XLF)9.6 percent0.09 percent
Energy Select Sector SPDR Fund (XLE)9.3 percent0.09 percent
Industrial Select Sector SPDR Fund (XLI)7.4 percent0.09 percent

What is the best mutual fund to invest in in 2024? ›

Best-performing U.S. equity mutual funds
TickerName5-year return (%)
GQEPXGQG Partners US Select Quality Eq Inv19.33
FGRTXFidelity Mega Cap Stock17.23
SSAQXState Street US Core Equity Fund16.89
FGLGXFidelity Series Large Cap Stock16.88
3 more rows
May 31, 2024

Should I get out of mutual funds now? ›

However, if you have noticed significantly poor performance over the last two or more years, it may be time to cut your losses and move on. To help your decision, compare the fund's performance to a suitable benchmark or to similar funds. Exceptionally poor comparative performance should be a signal to sell the fund.

Can you convert mutual fund to ETF without paying taxes? ›

The conversion itself is tax-free to the investor and switches from actively managed mutual funds, which aim to outperform the market. The primary benefit of the new ETF is more tax efficiency.

Is it safe to put all your money in an ETF? ›

ETFs can be safe investments if used correctly, offering diversification and flexibility. Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.

Can ETFs go to zero? ›

Yes, an inverse ETF can reach zero, particularly over long periods.

Why is ETF not a good investment? ›

Market risk

The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.

Are ETFs safe if the stock market crashes? ›

Industries that fare better during recessions supply essentials like utilities, health care, consumer staples, and technology. An ETF gives individuals an opportunity to invest in a sector-based fund with holdings that have proven to weather economic downturns. State Street Global Advisors.

What is the primary disadvantage of an ETF? ›

ETF trading risk

Spreads can vary over time as well, being small one day and wide the next. What's worse, an ETF's liquidity can be superficial: The ETF may trade one penny wide for the first 100 shares, but to sell 10,000 shares quickly, you might have to pay a quarter spread.

What are 3 differences between mutual funds and ETFs? ›

Mutual funds are priced once a day at the net asset value and they're traded after market hours. ETFs are traded throughout the day on stock exchanges just as individual stocks are. ETFs often have lower expense ratios and are generally more tax-efficient due to their more passive nature.

What is ETF advantages and disadvantages? ›

Advantages and disadvantages of ETFs

Investing in ETFs helps to mitigate unsystematic risks due to its passive investment strategy. It also lowers one's overall investment risk. It greatly helps with portfolio diversification. With the limited role of fund managers, ETF investments are comparatively cost-effective.

What are 3 advantages and 3 disadvantages of investing in mutual funds rather than stocks or bonds directly? ›

Some of the advantages of mutual funds include advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing, while disadvantages include high expense ratios and sales charges, management abuses, tax inefficiency, and poor trade execution.

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