ETF Investors Loved Vanilla Funds In 2014

January 12, 2015

Industry lore has it that strategic beta funds are slowly stealing market share from vanilla ETFs, but that's not what 2014 fund flows data shows.

Plain-vanilla funds are as dominant as ever, with healthy inflows in proportion to their market share. ETF investors continue to favor these funds' low-cost, straightforward access to global securities markets.

Strategic funds—so-called "smart beta"—are indeed gathering assets faster than the overall industry, and faster than vanilla funds.

Market share and fund flows must add up to 100 percent, so some funds must be losing the race for investor dollars.

2014's ETF losers were the idiosyncratic funds—ETFs with antiquated or nonsensical construction rules. Funds like the single-exchange PowerShares QQQ (QQQ | A-48) or the price-weighted SPDR Dow Jones Industrial Average Trust (DIA | A-74) were among the losers. Great news, as I argued in a recent blog about QQQ's outflows.

But the good news goes way beyond any single fund. In 2014, ETF investors made sensible choices across the board, sending cash to broad-based, cap-weighted funds and to funds with clear, economically grounded investment strategies—strategic funds.

Four Types Of Strategies's strategy designations help us see these trends, as they allow us to parse ETF flows.

In 2014, introduced the strategy designation for more than 1,600 of all U.S.-listed ETFs. These portfolio construction descriptors come in four flavors: vanilla, active, idiosyncratic and strategic. I defined these when I introduced them last May, and again a few days ago. Here's a quick guide:

Vanilla funds are the simplest. They're broad-based, cap-weighted, index-tracking funds meant to capture an entire market.

Strategic funds select and/or weight securities based on financial concepts such as financial statement analysis, macroeconomic assessments or risk metrics.

Idiosyncratic funds, in contrast, choose and distribute securities following nonfinancial rule sets.

Active funds have humans managing their portfolios. They don't track indexes.

Investors Getting Better-Grounded

The table below shows 2014 flows for each of these strategy groups, compared with what one might have projected, based on these groups' beginning market share. The "2014 Excess Flows" column shows how much more (or less) capital flowed into a strategy group than would be expected based on market share. 

Group 2014 Net Flows ($B) Proportional Flows Based On End-2013 AUM 2014 Excess Flows ($B)
Vanilla 177.6 178.2 -0.6
Strategic 62.8 48.8 13.9
Active 1.9 2.0 -0.1
Idiosyncratic -2.0 13.7 -15.7
N/A 3.6 1.1 2.4



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