ETFs: The Driving Force of the Funds Industry

Overview:

• In the first half of 2024, inflows into Canadian ETFs offset the outflows from mutual funds, leaving ETFs as the sole driver of growth for the overall fund industry.
• ETFs are still catching up in the fixed income space, indicating that there is still a portion of Canadian fixed income investors not being captured by the ETF market.
• Many investors may still turn to mutual funds for active strategies, but ETFs have been the go-to investment vehicle for many investors seeking index-based exposure.
• Investors are increasingly choosing to access equity and balance strategies through ETFs due to the wrapper’s benefits.

As 2024 progresses, ETFs have emerged as a dominant force in the investment landscape. With steady growth in assets and increasing investor interest, ETFs continue to reshape the fund industry offering an attractive alternative to mutual funds. Known for their cost efficiency, transparency and flexibility, ETFs have seen significant inflows this year, while mutual funds have faced consistent outflows.

In North America, ETFs continue to experience strong inflows while the mutual fund industry continues to bleed assets. This trend, observed in Canada since 2021, became even more pronounced in 2024 with inflows into Canadian ETFs offsetting the outflows from mutual funds, leaving ETFs as the sole driver of growth for the overall fund industry. Interest in fixed income ETFs also continues to rise despite the significant popularity of equity ETFs among investors. Fixed income is a strong growth avenue for ETFs, and active strategies are helping these fixed income ETFs pick up some ground.

In the first half of 2024, fixed income funds (including mutual funds and ETFs) accumulated new assets of $25 billion in Canada and $286 billion in the U.S., while equity funds (including mutual funds and ETFs) only had inflows of $17 billion and $43 billion respectively. Balanced funds have been losing sizeable assets in both Canada and the U.S.

ETF vs Mutual Fund Flows in Canada and the U.S.

Note: TD Securities heavily relied on data from IFIC, ICI, and Morningstar to complete this report, especially on mutual funds. To remain consistent, the report used mutual funds and ETF data from the same data sources. For example, IFIC and Morningstar were used for Canadian mutual funds and ETFs, and ICI and Morningstar were utilized for U.S. mutual funds and ETFs.

Gap Between ETFs and Mutual Fund Demand Widens

Unlike last year, the new assets gathered by ETFs in 2024 have been large enough to cover any outflows from mutual funds. ETFs have been the driving force behind the fund industry's growth in Canada with their low costs, flexibility, and transparency Over the first six months of 2024, CAD-listed ETFs attracted new assets of $33 billion while Canadian mutual funds have seen outflows of $8 billion. In total, mutual funds and ETFs both gathered new assets of $25 billion, meaning that ETFs are not only taking market shares from mutual funds, but also expanding the overall fund industry pie on their own.

The same trend has been observed in the U.S in 2024, with American ETF inflows being large enough to cover all outflows. In fact, together mutual funds and ETFs still brought in net inflows of $272 billion over the first six months of 2024 with $423 billion inflows into ETFs and $151 billion outflows from mutual funds.

Significant Flow Divergence by Asset Class

Despite overall positive flows in ETFs and negative flows in mutual funds, flows across the different asset classes varies significantly. Fixed income gained popularity in both ETFs and mutual funds while equities were more popular among ETF investors. Balanced funds, although small in ETFs, are a growing area for ETFs while mutual funds lost most of their assets in this space.

Inflows Diverge Between ETFs and Mutual Funds

The asset mix within mutual funds and ETFs is very different in Canada. Overall, equities still dominate the ETF market despite the fast growth of fixed income ETFs. In contrast, the mutual fund industry in Canada is dominated by balanced funds (funds holding both equities and fixed income), accounting for 45% of total assets.

In the U.S., the asset mix is different. Equity funds account for the majority of assets for both ETFs (81%) and mutual funds (54%). Fixed income funds are much more popular among mutual fund investors, accounting for 40% of total assets, while they only make up for 17% of total ETF assets.

Fixed Income Remains King Across Fund Vehicles

In ETF land, equity ETFs have led this year's flows with outsized inflows into broad market/large-cap index-based ETFs. In the first half of 2024, equity ETFs accounted for 60% of inflows in Canada and over 70% in the U.S. However, taking into account mutual fund flows, fixed income still dominates this year's fund inflows.

Unlike with equities and balanced funds where ETFs saw inflows and mutual funds had outflows, both fixed income ETFs and mutual funds experienced large inflows this year. One of the main drivers is active bond funds' popularity. In the U.S. and Canada, the stories are very similar. Overall, active bond funds have floated the fixed income boat this year.

Equities are Popular Among ETF Investors

Equities ETFs remain popular this year, especially those seeking exposure linked to the S&P 500 Index. However, the story is quite the opposite for mutual funds. In Canada, the outflows from equity mutual funds were overall moderate at $2.4Bn in the first half of 2024, while inflows into equity ETFs were $19Bn over the same period. This highlights that Canadian ETFs are not only taking equity assets from mutual funds, but also are attracting new assets and growing organically.

Canadian Balanced Funds Lose Ground

In Canada, balanced funds, which dominate the mutual fund space, have suffered the most outflows this year. In contrast, despite their relatively small AUM, balanced ETFs are growing very fast as they provide a one-stop shop for retail investors. Fees may be the major driver of significant outflows from balanced mutual funds and inflows into ETFs.