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The Year in ETFs so Far

Where have investors been putting their dollars?

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Half of 2021 is in the books. Here with me to provide a midyear look at the ETF landscape is Ben Johnson. Ben is Morningstar's global director of ETF research.

Hi, Ben, thanks for being here today.

Ben Johnson: Hi, Susan. Thanks for having me.

Dziubinski: So let's begin by talking a little bit about first-half performance through the lens of ETFs.

Johnson: I think if you look at the performance of major market segments through the first half of 2021, what's most interesting to me as we sit here in mid-June, is a reversal of some major trends that we saw take root in 2020, as most of the world went under lockdown, the economy closed. Here we are in the middle of 2021, and we're all re-emerging. And what you see is that some of the hardest-hit market segments in 2020, indeed, are re-emerging through the first six months of 2021. I think one of the most significant reversals that we've seen has been actually within the U.S. stock market-- specifically, if you look at the divergence between U.S. large-cap growth stocks, and U.S. small-cap value stocks.

So if you look specifically at the performance of the Morningstar U.S. Small Value Index, it's up 32% for the year to date through mid-June in 2021. In 2020, that index finished roughly flat. Meanwhile, the Morningstar U.S. Large Growth Index is up just under 9% for the year to date, it was up 39% in 2020. And underpinning that is really shifts in leadership we've seen at the sector and the industry level. And notably, some of those sectors that were most beaten down as the economy went on lockdown and ground to a halt are the ones that have rebounded more strongly off the bottom. And you look in the energy patch, specifically in energy services, oil and gas, drilling, some of the ETFs that invest in that sector have rebounded significantly from their early-2020 bottom.

And what we've seen is kind of a pause or a reversal in the performance of some of the best-performing ETFs of 2020, most notably in the clean energy space. Clean energy ETFs have been market darlings for a long time. A lot of that was capturing investors' enthusiasm around some form or another of "green new deal," growing global awareness around climate risk, and growing investment in new forms of energy. What we've seen thus far in 2021 is that a lot of that enthusiasm has fizzled, and performance has followed.

Dziubinski: Let's pivot and look a little bit at ETF flows for the year to date. Where have investors been putting their dollars?

Johnson: So, investors have been putting their dollars into ETFs at a record rate, first and foremost. Through mid-June, what we've seen is that ETFs combined have collected $443 billion in net new flows. At that rate, if we were to continue at this pace--which is no guarantee through the remainder of the year--ETF flows would absolutely shatter, they would blow to smithereens all prior records for calendar-year flows. And what I think that reflects is a number of different things. I think first and foremost, it's reflective of investor sentiment. Investors are looking now for a reason not to jump into the market. And they're jumping in with both feet, at least as evidenced by the ETF flows that we've seen thus far through this year.

If you look at it more granularly, where among the 2,600-plus ETFs are investors actually plunking down new money, they're going to the usual suspects. If you look at the top 20 ETFs, they represented a tiny minority of the 2,600-plus options on the menu, but they've represented nearly the majority of flows thus far in 2021. Among those 20 ETFs, there are just four that are not broadly diversified, market-cap-weighted, dirt cheap, and supremely tax-efficient. So investors are sticking to their knitting. They're generally putting their money into broad U.S. total market funds, emerging-markets total market funds, international total market funds, and core bond allocation funds that are underpinned by the Bloomberg Barclays Aggregate Index. They're keeping it simple, they're keeping it cheap, which is a trend we've seen now for quite some time within the ETF marketplace.

The other area that I would single out is specifically U.S. value stocks--and not just U.S. value stocks, I should stress actually but value stocks more broadly. If you look specifically across ETFs that fall in the Morningstar large-, mid-, or small-value categories, what we've seen is that through mid-June 2021, $68.5 billion of net new money has gone into U.S. stock value ETFs. Value has been resurgent, as I alluded to earlier, and investors are piling on in a way that they haven't in years.

Dziubinski: And then lastly, Ben, would you say that there any stories that have been particularly noteworthy in the ETF landscape in the first half of 2021?

Johnson: I think one of the more interesting, and in my mind entertaining, stories falls in the camp of ETF product development. So some may recall that while we were living in lockdown, and living, working, doing everything from home last year, there were three different work-from-home themed ETFs that were launched in 2020. Now, if you fast forward to today, what we've seen thus far this year, is that there are any number of different reopening-themed ETFs that are now being launched--like let's get back to work, let's get out in the world, let's invest in all of those companies that are positioned to benefit from things beginning to normalize. Be it cruise lines, airlines, hotels, you name it, we get out of our house and back into the world. And so, it's a trend we see play out time and time again, that product development tends to focus on whatever is right in front of our face, and whatever is performing well, too. And a lot of these sectors have performed quite well as things have begun to normalize. So I think that's interesting.

The other, less entertaining and more substantial developments that we've seen, I think are really highlighted by the recent conversion of four of Dimensional Fund Advisors tax-managed mutual funds into ETFs. These four funds collectively hold nearly $30 billion in investors' money, and I think they're just the latest marker, the latest data point, in this trend that we see which in my mind points to the fact that ETFs have arrived. ETFs I would argue have long since been mainstreamed. But when you begin seeing, and Dimensional Fund Advisors is just one among currently just two examples of mutual funds converting to ETFs. It reflects in my mind a growing recognition among not just product manufacturers, the asset managers, but also their clients, investors, that the ETF is just a wrapper. And it's a wrapper that has certain very important benefits for investors, namely cost efficiency, tax efficiency, availability to the extent that they trade like a stock on an exchange. And I think the direction of travel has long been clear, but it's clearer still, that ETFs are going to continue to gain market share from other formats, I think most notably from traditional mutual funds, as investors begin to recognize these benefits and allocate more of their capital at the margin to ETFs, or in other cases we could very well see more mutual funds convert to an ETF format in the future.

So it's another data point among many that ETFs have arrived, that they're more popular for investors. And they're more popular because they're doing good for investors at the end of the day. They're a format that allows investors to keep more for themselves and fork less over to either asset managers or Uncle Sam. And that's a good thing.

Dziubinski: That sure is. Ben, thank you for your perspective today on the first half of 2021. And we'll see you again in six months and talk a little bit about how perhaps things have changed through the remainder of 2021. We appreciate your time.

Johnson: Thanks so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.


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