(Bloomberg) — Investors are flocking to mutual funds at a record clip, driving a $1.5 trillion shift away from old-school investment vehicles and the ever-popular ETFs.
According to data compiled by Bloomberg Intelligence, the split between the two types of investment this year is expected to top $950 billion by 2021. Growing diversity is one measure of the speed at which ETFs are eating into their dominance of the mutual fund market.
The tide has been turning over the years for a business-friendly and tax-friendly structure. But in the year Market turmoil amid the Federal Reserve’s 2022 rate hikes and fixed-income volatility has fueled the divide even further as investors chose to play faster in the exchange-traded funds than their older brethren.
“Bonds, with their first major bear market in more than 40 years, have driven a significant industry shift from mutual funds to ETFs,” said Todd Sohn at Strategas Securities.
An ETF strategist said: “The Fed’s buying into fixed income ETFs in 2020, followed by inflation and a tighter Fed, has led to a big bear market for bonds in two years of ongoing development,” said an ETF strategist.
It saw mutual fund investors pull $480 billion from fixed income, the first annual outflow for the asset class since 2015. At the same time, ETFs held $184 billion in bond investments as of Dec. 15, less than the $200 billion seen. In the previous two years.
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An unusual year for stocks and bonds, with both markets nearing a total lock-up, has pushed money managers to look elsewhere for hedges amid rising inflation and tightening monetary policies. That may have prompted investors to increase their weighting in bonds, Son said.
“Given that downturn, there are investors who need to increase their weighting to fixed income, and using ETFs is another way to do that,” Sohn said.
ETFs are gaining ground across the board, amassing nearly $588 billion this year and on pace for their second-best annual run, according to Bloomberg Intelligence data. Meanwhile, mutual funds saw nearly $950 billion in cash flow out of the asset class, the largest outflow on record.
ETF investments make up about 28% of total U.S. fund assets, compared with 20% five years ago, Bloomberg Intelligence data shows.
The opportunity to lock in mutual fund losses and offset capital gains taxes, a practice called tax-loss harvesting, is also helping to drive the exodus out of mutual funds this year.
“Now may be an opportune time to enter ETFs that offer similar market access without the risk of facing large capital gains,” says ETF Think Thank. “The numbers suggest that many investors are making this transition away from mutual funds, typically taking lower-cost and more tax-efficient ETF wraps.”
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Still, the $15 trillion mutual fund universe is vastly larger than the $6 trillion ETF market. Mutual funds, for one, have longer tenures, and taxes on long-term holders’ gains make it difficult for investors to switch, said Drew Pettit, director of ETF analysis and strategy at Citi Research. People invest in mutual funds because the more established asset class offers more strategies.
“Not all mutual fund strategies out there have gone into ETFs,” Pettit said in an interview in Bloomberg’s New York office. Although, he said, the existing conversion of mutual funds into ETFs is gradually changing the dynamics.
“We don’t have this huge boom in hedge fund-like strategies and ETFs, but more and more are coming to market,” he said.
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–With help from Sam Potter.