Portfolio considerations
March 18, 2022
Flows into exchange-traded funds have accelerated dramatically in recent years, making it impossible to ignore that something important is going on in public investment markets.
Last year’s flows into U.S.-domiciled ETFs of more than $900 billion were a record—they easily eclipsed the previous peak of $500 billion in 2020. Over the past 10 years, inflows totaled $3.7 trillion. In the same span open-end mutual funds attracted $764 billion, about a fifth of the ETF total.1
In tandem with new inflows, market appreciation boosted total ETF assets under management to $7.3 trillion at the end of 2021, from about $1.4 trillion at the end of 2011.
What’s driving the success of ETFs?
We believe investors and financial advisors are recognizing the strengths of ETFs—namely their trading flexibility, diversification, lower costs, and potential tax benefits. In sum, they’re a powerful tool for constructing portfolios with relative ease. The shift in the prevailing compensation structure for financial advisors, away from commissions and toward asset-based fees, also has helped. In any case, three decades after the introduction of ETFs to the U.S. market, proof of their concept is here in that ETFs have survived in all kinds of market environments.
Note: Each bar represents total inflows (net of outflows) across all U.S.-listed ETFs as of December 31 of the year shown.
Sources: Vanguard, based on data from Morningstar, Inc.
The 2,837 U.S.-listed ETFs at the end of 2021 reflect a wide variety of strategies, from factor-based ETFs to funds that consider environmental, social, and governance criteria to finely tuned thematic approaches, such as technology-focused strategies. Even actively managed ETFs are increasingly part of the ETF ecosystem, though investors have not fully embraced them.
But inflows are mostly going into low-cost, indexed, core exposures. In 2021, 40% of the flows into U.S.-domiciled ETFs went to funds tracking the Standard & Poor’s 500 Index or total market indexes. In other words, the rise of ETFs is closely tied to the rise of indexing.
In addition to U.S.-focused ETFs, investors are using ETFs to explore various pockets of the investment universe. For example, interest in international strategies blossomed in 2021—with inflows rising almost sixfold from 2020 levels, to $165 billion.
Flows last year into bond ETFs—including municipal bond ETFs—were about even with their 2020 inflows, but the accelerating rise of bond ETFs in recent years has become a powerful part of the overall ETF adoption story.
Cash flows into U.S. equity ETFs were significantly higher in 2021 than for other ETF categories
Note: Data cover total inflows across all U.S.-listed ETFs for calendar years 2020 and 2021.
Sources: Vanguard, based on data from Morningstar, Inc.
It’s worth noting that the introduction of bond ETFs in 2002 was accompanied by questions. The thinking went like this: Because buying and selling individual bonds can be difficult at the best of times, a bond ETF composed of myriad individual bonds might become extremely difficult to trade when markets turn choppy.
But that hasn’t happened, and a pair of market dislocations loom large as proof points. Bond ETFs weathered the 2007–2009 global financial crisis. Perhaps most important, they also were crucial components of the investing landscape during the February/March 2020 COVID-19-related crash.
As bond market liquidity grew scarce in the early weeks of the pandemic, bond ETFs trading in the secondary market played a vital price discovery role. Although bid-ask spreads on bond ETFs widened, as one would expect in a volatile market, they widened far less than the spreads of individual bonds. And trading never froze. In the end, bond ETFs were a critical source of liquidity. The Federal Reserve folded corporate bond ETFs into its plans for expanded quantitative easing, signaling something more significant: ETFs are an integral element of contemporary financial markets.
The advantages of ETFs are clear—they include convenience and an improved investor experience featuring low costs, a breadth of choices, and potential tax efficiencies. ETFs give investors relatively easy access to swaths of the investment universe both broad and narrow, with plentiful liquidity. Many of these conveniences extend to fixed income, where ETFs have made the calibration of credit risk, duration, and inflation protection in portfolio construction easier than ever before.
As more assets flow into ETFs, Vanguard expects their advantages to grow, from improved liquidity to lower costs of ownership.
1 Source: Morningstar, Inc., as of December 31, 2021. Mutual fund data exclude money market funds and funds-of-funds. Ten-year net flows data cover 2012 through 2021. Mutual fund and ETF data include only U.S.-domiciled products based in U.S. dollars.
For more information about Vanguard funds or Vanguard ETFs, visit vanguard.com to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
Past performance is no guarantee of future results. All investing is subject to risk, including possible loss of principal.
Diversification does not ensure a profit or protect against a loss.
Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer's ability to make such payments will cause the price of that bond to decline.