ETFs Unscripted

By Edward Rosenberg and Sandra Testani

Join us for the next ETF Industry Update with Edward Rosenberg and Sandra Testani

July 13, 2022, 4:00 ET
Register Now

June 8, 2022, call highlights

ETF flows rebound in May¹

After experiencing their first month of outflows since 2018 in April, exchange-traded funds (ETFs) took in more than $66 billion in May.
Inflows were largest among U.S. bond ETFs, which added $35 billion in May. U.S. Treasury ETFs accounted for more than half the monthly bond inflows, taking in $18 billion. Municipal bond ETFs set a monthly inflow record with $6.5 billion in new money.
Flows into large-cap equity ETFs rebounded from April and significantly outpaced other stock categories.
Sector stock ETFs shed more than $1 billion, primarily due to outflows in the financial, energy, technology, industrial and real estate categories. ESG (environment, social and governance) ETFs experienced monthly outflows for the first time in several years.

This month’s focus: An index is an index, right?

The growth of passive investing has been huge. According to the Investment Company Institute, assets in U.S. passively managed funds recently surpassed actively managed funds for the first time.
Index funds offer important benefits to investors, including diversification, transparency, tax-efficiency, low turnover and low costs.
However, passive funds with similar names and similar strategies and benchmarks can deliver dramatically different results.

Returns can vary widely

In 2021, Morningstar’s large-cap growth equity category included 74 ETFs with a full calendar year return. Annual returns in 2021 ranged from a maximum of 56.96% to a low of -9.30%, for a range of more than 66 percentage points.
Among the 103 ETFs in Morningstar’s large-cap value category with a full calendar year return, 2021 returns ranged from 45.30% to 12.48%. The difference between the top performer and the bottom performer was nearly 33 percentage points.
These results highlight the different approaches ETFs may take in pursuing large-cap growth and large-cap value strategies. Some track broad market indices, while others may use custom indices designed to identify companies exhibiting specific growth or value characteristics.

Keep style differences in mind

While many ETFs in the growth and value equity categories have similar names, they may have different views on what constitutes “growth” and “value.”
Among value ETFs, strategies may vary, with portfolios focusing on low-priced companies, deep-value companies, dividend payers, dividend-growth companies, or a combination of factors.
Among growth ETFs, it’s important to understand what defines “growth.” Is it momentum? And if so, how does the fund define momentum and its corresponding index? Other strategies/indices may focus on companies with high historical growth, accelerating growth or growth at a reasonable price.

Know the risks of market-cap strategies

Passive funds that employ market-capitalization-weighted strategies may face concentration risk. Companies with the largest market caps typically comprise a significant portion of the index.
For example, in the Russell 1000 Growth Index, the top five holdings comprised nearly 40% of the index at the end of April. The index’s top 10 holdings represented nearly half of the index.²
Furthermore, large technology companies have constituted a big portion of the Russell 1000 Growth Index. At the end of April, the “FAANG” stocks comprised nearly 28% of the index, while nearly 39% of the index was invested in the “FAMGA” group.³
Large-cap growth portfolios that use measures other than size to identify growth—and track different indices—may not have this concentration.

Alternative indices can focus on fundamentals

Market-cap indices and portfolios don’t incorporate fundamentals into the stock selection process. Size is the primary measure, so they own stocks regardless of the underlying companies’ financial strength or health.
Conversely, funds that track alternative indices typically incorporate screens to identify specific characteristics.
For example, quality may be a screen in growth and value portfolios. ETF providers can develop custom indices focusing on attributes they believe define quality.

Understanding rebalancing schedules

Market indices typically have fixed rebalancing schedules.
For example, funds tracking the Russell indices rebalance once a year. Russell announces the changes in May and rebalances in June. In that 30-day window, stocks affected by the rebalance are subject to various trading anomalies, which ultimately may influence performance.
Alternatively, ETFs tracking custom indices can set their rebalancing schedules to seek optimal turnover. Notably, thanks to the in-kind creation/redemption mechanism underlying ETFs, more frequent turnover has not historically led to meaningfully higher capital gains distributions.

¹All data cited in this summary per Bloomberg and Morningstar Direct

²Source: Bloomberg as of April 30, 2022.

³Source: Bloomberg as of April 30, 2022. FAANG represents Facebook (now Meta), Amazon, Apple, Netflix and Google (now Alphabet). FAMGA includes Facebook (now Meta), Amazon, Microsoft, Google (now Alphabet) and Apple.

References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

The Russell 1000^® Index is a trademark/service mark of the Frank Russell Company. Russell^® is trademark of the Frank Russell Company.

When portfolio managers incorporate Environmental, Social and Governance (ESG) factors into an investment strategy, they consider those issues in conjunction with traditional financial analysis. When selecting investments, portfolio managers incorporate ESG factors into the portfolio's existing asset class, time horizon, and objectives. Therefore, ESG factors may limit the investment opportunities available, and the portfolio may perform differently than those that do not incorporate ESG factors. Portfolio managers have ultimate discretion in how ESG issues may impact a portfolio's holdings, and depending on their analysis, investment decisions may not be affected by ESG factors.

Edward Rosenberg

Senior Vice President
Head of Exchange Traded Funds

Sandra Testani, CFA, CAIA

Vice President
Product Solutions

▶
2022
2021
2020

Miss an update?

Review call summaries for previous updates.

May 11, 2022, call highlights

Investors exited ETFs in April¹

For the first time since August 2019, exchange-traded funds (ETFs) experienced monthly outflows. After taking in $97 billion in March, ETFs shed $10 billion in April. Year-to-date flows totaled $187 billion, lagging April 2021, when the year-to-date total was $325 billion.
Outflows were largest among U.S. equity ETFs, particularly large-cap equities, which lost $23 billion. Among styles, dividend equity ETFs experienced inflows of more than $7 billion. From a geographic perspective, international equity ETFs took in $7 billion.
Despite another challenging month for bonds, investors directed more than $8 billion into fixed-income ETFs, particularly government bond ETFs and those offering ultrashort duration exposure.
Approximately $2 trillion flowed into commodity ETFs.
Active ETFs continued to take in assets in April, while passive ETFs lost $16 billion.

This month’s focus: ESG Strategies

The ESG (environment, social and governance) category of ETFs can be a confusing space, loaded with jargon and acronyms. Furthermore, there’s no universal agreement as to what constitutes “ESG” or how to measure ESG compliance.
In general, the “E” considers investments related to climate, clean energy and water-related issues. The “S” includes considerations for health and well-being and worker safety measures. The “G” component examines board diversity issues and diversity, equity and inclusion initiatives.
Interest in ESG strategies has been growing, particularly in Europe, where they represent approximately 20% of total assets. In the U.S., ESG strategies represent approximately 2% to 3% of overall assets.
Bloomberg identifies approximately 130 ETFs in the U.S. as offering an objective tied to ESG. These ETFs saw record inflows in 2021 and continued to see inflows in April and year-to-date, despite the heightened volatility.

In our view, Millennials are much more in tune with ESG investing than other generational groups.
As massive amounts of wealth transfer from Baby Boomers to Millennials over the next several decades, interest in ESG investing likely will grow.
Ongoing technological advances, including automation, alternative energy applications and electric vehicles, should also generate mounting interest in ESG strategies.
Regulations—outside the U.S. and more recently in the U.S.—are also helping to create standards and transparency.

ESG investing has evolved in recent years. It is worth segregating distinct strategies. Some strategies attempt to identify and integrate ESG factors into an investment process (among many other factors that may include company fundamentals, valuations, etc.). Others seek to offer an ESG outcome.
Portfolios seeking an ESG outcome may employ one or more of the following strategies to meet specific goals.
Exclusionary strategies, historically also known as socially responsible investing (SRI), rely on clear-cut lists of companies a portfolio cannot own. For example, many portfolios exclude investments in coal, tobacco or gun manufacturing companies.
- “Best in class” may refer to strategies that incorporate ESG scores by overweighting companies with higher scores and underweighting those with lower ratings. These strategies generally invest across all sectors, even those that may be viewed as controversial by some investors. But they tend to focus on sectors they view as “leaders” while underweighting or avoiding sectors they believe are “laggards.”
- Thematic funds may concentrate investments around a specific theme, such as clean energy or low carbon emissions.
- Impact investing is another ESG category. Rather than simply focusing on good companies, portfolios seek to generate a measurable impact along with a financial gain. In building impact portfolios, many managers rely on the United Nations framework of 17 Sustainable Development Goals .

Some ESG advocates prefer an owner engagement approach, whereby shareholders attempt to influence company management on specific ESG issues.
Objectives vary but generally include gaining more understanding of a company’s approach to ESG risk management, encouraging transparency around ESG issues and influencing corporate practices.
Active ownership also includes voting shareholder proxies to align with ESG issues.
Key areas of focus often include net-zero emission targets, increased disclosures around diversity issues, executive compensation and labor practices.

As noted, understanding the different approaches to ESG can be challenging. And a lack of consistent definitions makes understanding ESG more difficult.
Several data providers score companies based on ESG factors. However, data and methodology can differ between vendors, resulting in different scores.
When companies do not report on various items, which may be more prevalent among smaller market capitalization companies, estimates can also lead to disparity in scores.
Greenwashing has become an area of regulatory focus. Regulators seek to limit unsubstantiated claims that strategies are more sustainable or environmentally friendly than they truly may be.

¹All data cited in this summary per Bloomberg and Morningstar Direct

April 6, 2022, call highlights

Flows stronger than in February¹

Exchange-traded funds (ETFs) took in $97 billion in March, compared with nearly $79 billion in February. Year-to-date flows totaled $196 billion, lagging March 2021, when the year-to-date total was $251 billion.
Equity ETFs were the top recipients, taking in nearly $70 billion. Within the asset class, investors continued to favor U.S. large-cap equity ETFs.
Despite a challenging month for bonds, investors directed more than $18 billion into fixed-income ETFs. Approximately $11 billion went into government bond funds.
Amid growing inflationary pressures, more than $10 billion flowed into commodities ETFs, pushing the year-to-date total to $18 billion. Gold funds captured most of the inflows. Select commodities funds include derivatives or options on the underlying commodity, underscoring the importance of examining the fund’s structure before investing.

This month’s focus: Actively managed ETFs

Despite this year’s volatile backdrop, 115 new ETFs launched in the first quarter, 71 of which are actively managed. This continues the trends observed in 2021, a record year for ETF launches, when active ETFs outpaced passive ETFs.
Nevertheless, most of the industry’s assets remain in passive, index-tracking ETFs.
Current market conditions have led to increased performance correlations between asset classes. These conditions, combined with rising interest rates, historically have favored active management.

March 31 marked the second anniversary of the first semitransparent active (STA) ETFs trading. Today, there are 45 STA ETFs.
These ETFs do not disclose their specific holdings every day, thus preserving the investment manager’s proprietary strategy. Instead, they mask all or most of their holdings via different SEC-approved methods.
STA ETFs represent approximately $5 billion in assets. They are generally available exclusively from registered investment advisors. But recently, one large full-service brokerage firm made two STAs available and others are considering adding STAs.
Now that the structure has reached the two-year mark, we believe more platforms may offer STAs. Additionally, demand for these products is growing.
Initial concerns some industry participants had about STA trading stability in volatile markets have faded.

Transparent active ETFs report their entire portfolio of holdings daily.
This segment contains more than $330 billion in assets and has been growing at a faster pace than the ETF market overall.
The transparent active market segment has experienced a 67% compound annual growth rate over the last three years, compared with nearly 28% for passive index-tracking ETFs.
Fixed-income ETFs comprise approximately 60% of the transparent active segment.

The transparent active approach allows managers to remain nimble and flexible, particularly when managing interest-rate sensitivity.
These ETFs aren’t beholden to ratings agency definitions of investment-grade and high-yield credit. Instead, the portfolio managers can conduct their own credit research to determine a security’s quality. Accordingly, active managers don’t have to sell whenever a ratings agency changes a security’s rating.
Active managers can provide investors access to out-of-benchmark securities. This may be particularly appealing in the municipal bond market, where broad indices don’t offer exposure to many sectors and issuers. What’s more, market indices tend to overweight general obligation bonds and exposure to California and New York, which are among the largest issuers.
The market has also seen an uptick in transparent active equity ETFs. Many equity indices have infrequent rebalancing schedules, which could cause those indices—and the portfolios that follow them—to drift from its intended focus. Active managers can avoid this style drift.
Active ETFs focused on environmental, social and governance (ESG) qualities may be better able than passive funds to identify companies with improving ESG characteristics.

¹All data cited in this summary per Bloomberg and Morningstar Direct

March 9, 2022, call highlights

Russian invasion/heightened market volatility

Russia’s invasion of Ukraine took center stage in late February, triggering a devastating humanitarian crisis. Russia’s aggression also led to severe global market volatility.
In addition to Western nations implementing significant sanctions on Russia, the major market benchmarks removed Russian securities from their indices. Furthermore, U.S. stock exchanges delisted Russian securities.
The European Union removed several Russian banks from SWIFT (Society for Worldwide Interbank Financial Telecommunication), a global messaging network for financial institutions. The Moscow Stock Exchange closed, and the Russian ruble collapsed.
ETF share of total trading has remained elevated, even as overall volumes have generally declined.
Russia-dedicated ETFs experienced steep price declines, prompting U.S. and European exchanges to stop trading them.

Flows improved in January¹

ETFs took in nearly $79 billion in February, close to four times the volume in January. However, flows continued to lag 2021’s record pace.
U.S. equity ETFs were the top recipients of investor dollars. Within the asset class, investors overwhelmingly favored large-cap equity ETFs.
Despite outflows from Treasury inflation protected securities (TIPS) and high-yield bond ETFs, the broad fixed-income asset class took in approximately $10 billion. Most of the money went to government bond ETFs.
Flows into ESG ETFs totaled approximately $1 billion for the month, up from January but much lower than last year.

This month’s focus: ETFs and taxes²

Expectations for significant tax policy changes from the Biden administration have yet to materialize. But there’s still a chance the administration will push for higher tax rates and other changes.
Many of the provisions of 2017’s Tax Cuts and Jobs Act are set to expire in a few years, unless Congress intervenes. Current income tax rates, standard deductions and caps on state and local tax deductions are among the provisions set to expire by the end of 2025.
We believe this situation highlights the importance of advisors engaging in ongoing tax management.

Investors can use realized losses to offset capital gains or ordinary income, up to $3,000 (joint filers) each tax year. Investors may carry forward any losses exceeding $3,000 indefinitely.
Investors can’t use tax-loss harvesting if they engage in a wash sale. Selling a security at a loss and purchasing the same or “substantially identical” security 30 days before or after that sale results in a wash sale. The term “substantially identical” is subjective, but regarding ETFs, it generally refers to portfolios of similar securities.
Investors can harvest tax losses at year-end or proactively throughout the year.
When converting a Traditional IRA to a Roth IRA, investors may be able to use the tax-loss harvesting strategy to reduce the resulting tax bill.

Tax efficiency is a key benefit of ETFs, largely due to the way in which ETFs create and redeem shares. The process helps limit the number of taxable events in the portfolio.
The structure lets investors—not the portfolio managers or fellow shareholders—decide when they want to sell shares and realize a taxable gain.
In 2021, 69% of mutual funds distributed capital gains, compared with only 10% of ETFs. Among equity portfolios, 89% of mutual funds and 11% of ETFs distributed gains. For fixed-income portfolios, 43% of mutual funds and 21% of ETFs paid gains.3
Morningstar recently published a 10-year study4 that concluded:
- ETFs distributed fewer capital gains than mutual funds.
- Among ETFs that distributed capital gains, the gains were smaller than they were for mutual funds.
- The primary benefit of ETFs is that they allow investors to defer capital gains. Each investor decides when to sell and take a gain.

Most mutual funds, ETFs and other investment vehicles must distribute capital gains and income at least annually.
Most mutual funds distributed capital gains in 2021. In some cases, those gains represented a sizable percentage of the fund’s net asset value (NAV) and would have resulted in a sizable tax bill. Thankfully, a fund’s cost basis is adjusted upward by the amount of the taxable gain distributed.
If an investor owns a fund that pays high gains every year, they may want to consider another alternative. Now may be a good time, particularly if the fund recently adjusted its cost basis upward and the NAV declined in the recent market sell-off. Of course, selling the position may trigger a long-term gain on the sale, so it’s important to consider the trade-offs.
Deciding when to sell an investment is often difficult. After all, no one enjoys paying a capital gain. But if an investment philosophy has changed or the investment vehicle has changed, it may be time to sell. This may be an ideal time for investors to move into something that's either more tax efficient or more appropriate for their overall strategy.

¹ETF flow data per Bloomberg and Morningstar

²This material is for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation

³Morningstar Direct, as of 12/31/2021</p>

⁴ETFs Have A Tax Advantage Over Mutual Funds. Feb 8, 2022

February 9, 2022, call highlights

Flows slow to start 2022*

Despite a volatile month, ETFs took in approximately $37 billion in January. This marked a significant drop from January 2021 inflows of approximately $66 billion.
Building on a trend that emerged in late 2021, flows into international equity ETFs were robust. In terms of equity styles, flows favored value ETFs over growth ETFs. In the U.S., value funds took in approximately $17 billion, while growth funds experienced outflows of $13 billion.
Against a backdrop of soaring inflation, U.S. fixed-income ETFs logged their first outflow month since March 2020.
The dispersion between passive ETF flows and active ETF flows tightened in January. Flows continued to favor passive funds, but the gap narrowed amid mounting volatility.

This month’s focus: Rates, inflation and volatility fuel heightened uncertainty

At its January policy meeting, the Federal Reserve (Fed) indicated tackling inflation is a key priority. High inflation remains among the biggest threats facing the economy and markets.
The Fed opened the door for rate hikes to potentially start in March. This led to expectations for four to five quarter-point rate hikes in 2022.
Following the Fed’s meeting, interest rates rose, and fixed-income returns generally declined.
In his post-meeting press conference, Fed Chair Jerome Powell highlighted the economy’s strength and low unemployment. Some observers took this as a sign the Fed will tolerate elevated volatility as it tightens monetary policy.
Signs that interest rate and inflation worries are creeping into corporate bond markets began to emerge. But so far, corporate bonds haven’t experienced material effects.

The following points represent where we may be finding investment opportunities.

In general, volatile, rising-rate environments create challenges for rate-sensitive bonds, particularly government and other high-quality securities.
Shorter-duration bonds, or those with less price sensitivity to interest rate changes, may be appropriate in this climate.
Among corporate bonds, sectors with less exposure to event risk,1 including finance companies and life insurers, may be appropriate.
Emerging markets bonds also may be helpful in the current climate, as we believe they have relatively attractive prices. Additionally, many emerging markets countries have shored up their financial positions over the last several years. Furthermore, many commodity-producing emerging markets have been reaping benefits from rising commodity prices.
Similar to their taxable counterparts, shorter-duration municipal bonds (munis) generally fare better than longer-duration munis when rates are rising. Select out-of-index municipal sectors, including hospitals and communities, may offer value in the current climate.

Compared with bonds, stocks historically have performed better when interest rates are rising. In our view, quality companies offer the most attractive potential in the rising-rate environment.
In general, we view firms with stable cash flows and high profit margins as “quality” companies.
Higher rates often benefit traditional value-oriented stocks, such as bank stocks. Higher rates often accompany improving economic activity, which generally leads to more loan activity for banks. At the same time, rates on those loans are higher, typically leading to greater cash flows for banks.
Higher interest rates also tend to increase the appeal of dividend-paying securities, such as utilities stocks and real estate investment trusts.
The recent outperformance of value stocks versus growth stocks is partly due to sharp volatility in the information technology sector. We still see several longer-term trends (automation, electric vehicles, hybrid work models) that should support growth stocks over time.

Annual headline inflation jumped to 7.5% in January, the largest rate since 1982. Many investors have never experienced this level of inflation.
Supply chain issues, chip shortages and supply/demand imbalances are the main culprits. Resolving these issues will take time, but we do believe inflation may peak in the next couple months.
Once inflation hits its high point, it’s unlikely to decline quickly. In our view, inflation will moderate over time and settle well above pre-pandemic levels.

*ETF flow data per Bloomberg and Morningstar
¹Event risk refers to unforeseen or unexpected events that can lead to losses for investors.

Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.

January 12, 2022, call highlights

ETF 2021 flows hit new record¹

U.S. ETF inflows topped $900 billion in 2021, nearly doubling the previous record of $509 billion in 2020. Equity funds remained the top recipients, garnering 75% of the flows, or $688 billion. This compared to $247 billion in 2020. Flows significantly favored U.S. equities over international stock funds.
Despite headwinds from rising rates and inflation, fixed-income ETFs still outpaced 2020’s flows and set a record. Investors sent $214 billion into fixed-income ETFs in 2021, versus $211 billion in 2020.
Four hundred fifty ETFs launched in 2021, two-thirds of which are actively managed. Additionally, more than a dozen mutual funds converted to ETFs.
Assets in U.S. ETFs surpassed $7.2 trillion in 2021. American Century Investments ETF assets crossed the $10 billion market in early 2022, landing the firm among the fastest-growing ETF providers.
The potential for rising taxes from the new presidential administration likely fueled some interest in ETFs, given their tax efficiency. While more than 80% of equity mutual funds paid a capital gain last year, only 8% of equity ETFs paid a gain. Among fixed-income portfolios, 43% of mutual funds paid a capital gain versus 21% of ETFs.2

This month’s focus: 2022 outlook

In our view, these factors are shaping our 2022 outlook:

The big reopening rally is behind us, and economic growth and investment returns should moderate amid a generally positive backdrop.
High inflation remains among the biggest threats facing the economy and markets.
We remain wary of a potential Federal Reserve policy misstep—that is, raising rates too quickly and/or too much, creating headwinds for long-duration assets and debt-ridden companies.
Since the pandemic began, central banks have injected $32 trillion into global markets to help combat COVID-19’s economic effects. In 2022, the policy support from central banks likely will begin to fade, leaving economies to stand on their own.

Against this backdrop, we have identified four themes we believe will capture investors’ focus this year:

The SEC is working on common language and rules for all portfolios pursuing ESG goals. This should help put all ESG products on a level playing field and provide a common ESG definition for investors.
Younger generations are more ESG focused, which should contribute to the growing interest in ESG strategies. Last year, ESG ETFs took in a record $38 billion.
Advisors must determine the right ESG approach for their clients. Whereas the early days of socially responsible investing involved excluding “sin stocks,” today’s ESG strategies are more comprehensive. They typically include screens to avoid certain company/industry attributes and/or other tactics designed to optimize exposure to select businesses and strategies.

Sustainability: Sustainability focuses on meeting the needs of the present without compromising the ability of future generations to meet their needs. There are many different approaches to Sustainability, with motives varying from positive societal impact, to wanting to achieve competitive financial results, or both. Methods of sustainable investing include active share ownership, integration of ESG factors, thematic investing, impact investing and exclusion among others.

Historically, low-cost index strategies have gained much of the industry’s assets and flows. Now, we’re seeing more interest in alpha generation and, accordingly, more focus on active ETFs³.
We also remain hopeful that semitransparent ETFs4 become more widely available. We look forward to the SEC approving the semitransparent structure for non-U.S. equities and fixed-income, though we don’t think this will happen in 2022. Among the 45 semitransparent ETFs available today, most are U.S. large-cap equity funds, and many are clones of mutual funds.
We expect active ETFs to gain ground.

Headline inflation ended 2021 at 7%, a 40-year high. We continue to believe pandemic-related influences, including supply chain disruptions, labor market shortages and rising commodity prices, are mostly to blame. Once these pressures subside, we expect inflation to settle above pre-pandemic levels, perhaps at a range of 2.5% to 3%.
At current levels of inflation, the Fed has started tightening. Policymakers started their policy shift by tapering asset purchases. They likely will turn to rate hikes late in the first quarter. This action may not bode well for long-duration assets, particularly longer-maturity Treasuries.
In previous rising-rate environments, the value equity style has outperformed the growth style, but growth equities may still play an important role if economic growth slows.
Assuming the Fed doesn’t make a policy error, investors may want to focus on yield-generating investments to help offset the price declines resulting from higher rates. These include REITs, high-yield bonds, emerging markets debt and multi-sector income portfolios. Additionally, preferred securities may deliver shorter-duration and higher yields.

In last year’s robust economic recovery, high beta generally led factor returns. We don’t expect that trend to continue in 2022.
Given our expectations for the economy and corporate earnings to moderate this year, quality companies may have an advantage over lower-quality, speculative firms.
We also believe international equities offer potential. U.S. stocks have enjoyed multiyear performance advantages over non-U.S. stocks. But now, non-U.S. stocks may have a notable valuation advantage over U.S. stocks. This may be particularly evident in Europe, given the European Central Bank seems unlikely to raise rates any time soon.

¹ETF flow data per Bloomberg.
²Capital gains as reported by Morningstar Direct as of 12/31/2021.
³An active ETF has investment managers or teams researching and making decisions about the portfolio’s asset allocation and holdings.
⁴A semitransparent ETF is an actively managed ETF that doesn’t disclose its holdings daily to protect the integrity of the portfolio manager’s investment strategy.

December 8, 2021, call highlights

ETF year-to-date flows approach $800 billion*

As volatility edged higher, monthly net new flows into ETFs slowed in November to approximately $70 billion, bringing year-to-date total flows to nearly $800 billion. The year-to-date total through November is already $300 billion higher than 2020’s record, with December 2021 data still unfolding.
U.S. equity funds remained the top recipients, with a significant portion of assets flowing to broad-based large-cap strategies.
Among fixed-income ETFs, TIPS ETFs remained popular amid rapidly rising inflation.
In another first for the industry, an ETF that shorts the positions of a competitor ETF launched in November.

This month’s focus: Key ETF themes in 2021

In our view, here are the key industry themes in 2021:

Growing interest in/acceptance of active ETFs
ESG goes mainstream
Taxes and tax efficiency
Soaring inflation
The rise of the retail investor

* ETF flow data per Bloomberg.

As of today (Dec. 8), of the 424 ETFs launched in 2021, 264 are actively managed, highlighting the expanding demand for these products. Active ETFs held $100 billion at the end of 2019. Today, they hold nearly $200 billion.^*
Year to date, active ETFs took in $80 billion in net new flows.^*Although active funds comprise only 5% of the ETF market, they account for approximately 12% of the year-to-date flows.
Initially, fixed-income strategies represented 85% of the active ETF space, while equity funds comprised 15%. Today, equity strategies have grown to nearly 30% of the active universe.
Two trends have aided the growth of active equity ETFs: the launch of semitransparent structures and conversions of mutual funds to ETFs.
There are currently 25 semitransparent ETFs with a total $2 billion in assets. So far, the structure is only available in U.S. strategies, and most semitransparent ETFs are large-cap equity funds.

*ETF flow data per Bloomberg.

Forty socially responsible ETFs launched in 2021, including actively managed portfolios.
Year to date, ESG funds took in $30 billion, bringing the total ESG ETF assets to approximately $126 billion.
Whereas the early days of socially responsible investing involved excluding “sin stocks,” today’s strategies are more comprehensive. They typically include screens to avoid certain company/industry attributes and other tactics designed to optimize exposure to select businesses and strategies.
Generational influences and demographics likely will drive further demand for ESG strategies.

Taxation has dominated the first year of the Biden administration. Anticipating higher taxes, ETF investors have poured nearly $18 billion into municipal funds, outpacing corporate bond, government bond and bank loan strategies.^*
In addition to the specific tax advantages of municipal securities, the ETF structure typically offers greater tax efficiency than other account structures.
The “in-kind”** process characteristic of the ETF structure can mitigate some of the taxes when the portfolio experiences large redemptions.
Similarly, the structure and management of ETFs generally lead to minimal capital gain distributions. For example, in 2020, 61% of all equity mutual funds paid a capital gain, while only 3% of equity ETFs did. On the fixed-income side, 41% of mutual funds and 20% of ETFs paid capital gains.

*ETF flow data per Bloomberg.
**ETF managers accommodate investment inflows and outflows through the in-kind share creation and redemption process. This allows for the exchange of ETF shares for a basket of securities instead of cash. The process enables managers to shed securities that may generate significant capital gains.

For the first time in nearly 30 years, investors are dealing with meaningful inflation rates. Demand from the economic reopenings combined with supply chain disruptions and other factors are driving consumer prices sharply higher.
At the same time, interest rates are likely on the rise. These factors are prompting investors to reevaluate their strategies to stay ahead of inflation and combat rising rates. Many investors today have never experienced a period of prolonged inflation.
ETFs provide and easy and efficient way for investors to reposition portfolios based on the rate and inflation environment.
In addition to dedicated inflation portfolios, investors may consider multisector bond strategies, high-yield bonds, short-duration strategies or preferred securities.
On the equity side, dividend-paying stocks, particularly those with growing dividends, and REITs may help mitigate rising inflation.

With the pandemic forcing many people to work from home, the number of brokerage accounts exploded.
JPMorgan estimates retail investors now account for approximately 20% of total trading volumes in the U.S. While down from 25% to 30% during the first two months of 2021, the current percentage is still higher than the pre-pandemic range of 10% to 15%.***
According to market research firm Cerulli Associates, among investors with at least $100,000, self-directed accounts have tripled from 13% in 2015 to 48% in 2021. Cerulli says the money going into self-directed accounts could top 25% of total assets, creating challenges for advisors trying to provide holistic plans.

*** Source: Financial Times. November 30, 2021.

November 11, 2021, call highlights

ETF year-to-date flows outpace last year’s record run¹

Net new flows into ETFs totaled $82 billion in October, bringing year-to-date total flows to approximately $720 billion. This year-to-date total is more than twice the level of October 2020.
ETF investors continued to pour money into equity funds, which took in approximately $57 billion in October.
Amid ongoing concerns about rising inflation, TIPS ETFs remained popular. Investors also demonstrated a preference for higher-quality bond ETFs and short/intermediate duration portfolios. Additionally, high-yield inflows rebounded as rates moved higher.
The first ETFs to trade Bitcoin futures² made their debut in October, taking in $1.2 billion.

This month’s focus: Defining quality

Many firms use “quality” to define their portfolios, but the term has different definitions across the industry.
Within the equity market, quality typically refers to stable, profitable companies without a lot of debt.
Within the bond market, quality usually refers to the debt issuer’s creditworthiness.
With growth likely to slow and interest rates on the rise, “quality” companies are facing challenges to their valuations and purchasing power. Maintaining high and stable margins (often key components of quality screens) may become more difficult in this environment.

¹ETF flow data per Bloomberg.
²Bitcoin futures track the price movements of Bitcoin. They enable investors to gain exposure to Bitcoin without having to hold the underlying cryptocurrency.

Some managers consider quality a key factor associated with higher return potential. Factor portfolios target specific drivers of returns, such as quality, or combine various drivers into a multifactor portfolio.
These portfolios may or may not be based on an index. Either way, portfolio managers generally rank securities based on their definition of quality and purchase securities with the highest scores.
Measures of quality may be very narrow, such as ranking stocks by return on equity, or more comprehensive and incorporate measures such as leverage.
Focusing on quality companies tends to beneficial during mid-cycle economic periods when growth is becoming scarce.

In our view, quality is more than a factor; it’s a reference point for selecting companies.
We have a comprehensive view of quality. We look at fundamentals, such as profitability, earnings and sales variability and leverage. And we also examine metrics that can help understand market sentiment, including drivers of upgrades/downgrades and governance issues around quarter-end reporting.
For dividend-paying strategies, we want to make sure management isn’t taking on a lot of debt to pay or raise the dividend. So, we’ll evaluate a company’s ability to maintain or raise its dividend payment throughout the economic cycle.
Perhaps our most important insight is how we use quality metrics to eliminate unattractive companies. We agree with the premise that quality outperforms over time. But we’re also aware that low-quality companies historically have underperformed—often significantly—over time. Our screening efforts seek to avoid low-quality companies.

Identifying quality among the highest-rated investment-grade issuers may come with slightly lower expected risk and potential yield. But moving down the ratings scale and using research to dig into company fundamentals to uncover quality can really make a difference in returns.

October 6, 2021, call highlights

ETF flows remain on record-setting pace¹

Net new flows into ETFs totaled $45 billion in September, bringing year-to-date total flows to approximately $637 billion. This year-to-date total is more than twice the level of September 2020. For the month, large-cap stock ETFs led the way.
Reflecting mounting inflation concerns, TIPS ETFs took in nearly $3.5 billion in September. Year to date, investors have poured $28 billion into TIPS products.
Flows into ESG-focused ETFs totaled $2.5 billion in September and nearly $30 billion year to date.
The fourth quarter tends to be the biggest quarter for ETF flows.

This month’s focus: What indices can and can’t do for you

Of the more than 300 new ETFs launched so far this year, two-thirds are actively managed.
Over the last three years, index ETFs have grown an average 19% annually. Active ETFs have grown 45% to 50% for that same time frame.
Still, 90% to 95% of all ETF assets are in index products. While active is the fastest growing segment of the ETF space, it still represents a small portion of the total industry.

¹ETF flow data per Bloomberg

Traditional indexes, such as the S&P 500 and the Russell 1000 indices, weight stocks based on market capitalization. This can lead to stock or sector concentration and a mega-cap bias.
Each index has its own starting universe, methodology and rebalancing schedule. This can lead to ETFs with seemingly similar names, such as “large-cap value,” experiencing dramatically different results.
For example, Morningstar’s large-cap value category includes a wide variety of products, including approximately 93 ETFs. Performance variations are wide, reflecting the sharp differences in index construction.

In general, broad fixed-income indices, including the Bloomberg Barclays U.S. Aggregate Bond Index, overweight the largest debt issuers.
Additionally, Bloomberg’s broad fixed-income index contains more than 12,000 bonds (as of September 30, 2021). For managers tracking the index, owning all those securities is nearly impossible. To match the index criteria, portfolio managers must make active decisions about which securities to own. But how are they making those decisions?
In our view, all “indexed” fixed-income funds are really active in some way, shape or form, because managers can't replicate the broad index. That’s why we believe it makes sense for fixed-income products to be active products. All American Century Investments fixed-income products are actively managed, given the inefficiencies and limited inventory associated with fixed income.

Theoretically, the S&P 500 Index is a market-cap weighted index representing the 500 largest U.S. companies.
But getting into the S&P 500 Index requires a committee vote. Therefore, committee members may vote into the index companies that aren’t among the 500 largest. And those that are among the largest may not be included for extended periods of time based on subjective measures.
It’s also important to examine how indices respond to market activity. For example, when the market dropped sharply at the end of the first quarter of 2020, certain indices postponed their rebalances. Those were unusual moves indicative of subjective decision-making.

September 1, 2021, call highlights

August ETF flows remained robust¹

Net new flows into ETFs reached $60 billion in August, bringing the year-to-date total to nearly $575 billion.
Approximately half of the month’s flows went into large-cap equity ETFs. And for the first time in several months, flows into value and growth ETFs were positive.
Other ETF categories, including fixed-income (corporate, government and TIPS) and ESG, also experienced inflows. Energy ETFs represented the only category experiencing outflows for the month.

This month’s focus: ETFs and Taxes

Spending bills working their way through Congress contain provisions to hike U.S. tax rates.
For example, Americans face a potential increase in the top marginal income tax rate from 37% to 39.6%. The top capital gains rate may jump from 20% to 39.6%.
Furthermore, high-income households may lose the ability to step up their cost basis on capital gains of more than $1 million.
While we don’t yet know how all of this will pan out, the prospect of higher taxes is prompting investors to consider tax-advantaged products and strategies.

Tax-loss harvesting is the process of using portfolio losses to offset portfolio gains, which may result in a lower overall tax liability.
Investors can use their realized losses to offset capital gains or ordinary income, up to $3,000 in a single year for joint filers ($1,500 for single filers). Investors may carry forward any additional losses indefinitely.
To take advantage of tax-loss harvesting, you must avoid a wash sale by not owning the losing investment for at least 30 days. That is, once you sell a security at a loss, you can’t purchase the same or “substantially identical” security within 30 days (before or after the sale).
Tax-loss harvesting is difficult to implement when the stock market has remained on an extended rally. However, advisors can sift through older lots of securities in search of potential losses to offset current gains. American Century Investments offers a proprietary tool that can help identify portfolio losses.

ETFs pay capital gains, despite some myths to the contrary. However, the percentage of equity and fixed-income ETFs that pay capital gains is low—on an absolute basis and compared with other investment alternatives. And when ETFs do pay gains, those gains tend to be lower than gains paid by comparable mutual funds and other portfolios.
Most ETF managers (including American Century) provide estimates of their annual capital gains distributions each October. If you want to avoid those gains before they’re paid (typically in December), you can sell the ETF.
But remember, selling your ETF shares may trigger a capital gain on that sale. So you’ll have to decide if taking that gain makes more sense than holding the shares through the distribution period. Whether the fund is paying short-term (higher tax rate) or long-term (lower tax rate) gains also is a factor worth considering.
When you review capital gain estimates, it’s helpful to consider them as a percentage of the fund’s NAV, rather than dollars. For example, if a fund’s NAV is $15 and the capital gain is $2 per share, the gain is 13% of the share price. But for a fund with an $80 NAV paying that same $2-per-share capital gain, the gain is only 2.5% of the share price.

The tax efficiency of ETFs largely stems from the process of creating and redeeming ETF shares. Many ETFs require authorized participants to create and redeem shares “in kind,” or to exchange ETF shares for a basket of securities rather than cash.
This allows the ETF portfolio manager to avoid selling securities to raise cash to meet redemptions, thus preventing capital gains distributions.
On the other hand, mutual fund portfolio managers may have to sell securities to raise cash at the end of the day. Therefore, redemptions may pass along unsolicited capital gains to all shareholders in the fund.

Vehicle choice is a critical component of portfolio construction. We believe ETFs have historically proven to be more tax efficient than other vehicles.
Our research indicates ETFs have distributed capital gains less frequently and at lower amounts than comparable mutual funds. This applies to equity, fixed-income and active mutual funds versus their respective ETF counterparts.
Because they tend to pay larger and/or more frequent capital gains, mutual funds may make more sense for retirement or other tax-advantaged accounts. Meanwhile, ETFs may be the more appropriate vehicle for taxable investment accounts.

¹ETF flow data per Bloomberg.

August 4, 2021, call highlights

Year-to-date ETF flows surpass 2020’s record level¹

Net new flows into ETFs set a record in 2020, topping $500 billion for the year. In 2021, it took only seven months for flows to surpass the $500 billion mark. Through July 2021, year-to-date net new ETF flows totaled nearly $520 billion.
Year to date through July, large-cap equity ETFs took in $209 billion, the largest share of all categories. Despite experiencing outflows in July, net new flows into value ETFs reached $45 billion year to date. Inflows returned to growth ETFs in July, and the year-to-date intake turned positive, reaching nearly $2 billion.
Flows into fixed-income ETFs totaled $60 billion through the first seven months of 2021. Approximately $40 billion of that money flowed into shorter-duration strategies. TIPS and muni ETFs also continued to experience robust inflows.
ESG-oriented ETFs remained popular, taking in nearly $53 billion year to date.

This month’s focus: Fixed-income ETFs

Relatively low expense ratios and capital gains distributions are primary reasons investors choose fixed-income ETFs versus other alternatives.
Daily liquidity and transparency are additional benefits of fixed-income ETFs. Investors can easily see the bonds that comprise the portfolio, and this transparency can help investors meet their yield and duration objectives.
With fixed-income ETFs, investors have easy access to a variety of bonds and bond types, making it much easier to own versus buying and selling individual bonds.

The size and composition of broad fixed-income indices make active management more attractive. For example, the Bloomberg Barclays U.S. Aggregate Bond Index, a common measure of the U.S. bond market, contains almost 10,000 bonds. It’s nearly impossible for an ETF to own all the securities represented in the index. In fact, owning even 60% to 70% of the index would be a big challenge for most ETFs.
Passive ETFs seek to replicate the index and its performance by investing in a sample of index securities. But choosing that sample of securities requires active decision-making. So, because there’s active decision-making in passive portfolios, it may make more sense to own an active portfolio that seeks to outpace, rather than replicate, the index.
Active fixed-income ETFs can adjust portfolio holdings to potentially generate higher returns and higher yields than the index. They also may provide better downside risk management by adjusting duration as rates rise.
Additionally, in today’s climate of low rates and tight spreads, research-based security selection may offer advantages. It can help portfolio managers avoid high-risk securities and focus on bonds with attractive valuations and the potential for benchmark-beating returns and credit rating upgrades.

Every ETF basically trades the same way. It’s important to remember the volume of an ETF is what has already traded. And it has nothing to do with the liquidity of the ETF; it only shows what's happened in the past.
You can trade any ETF in large amounts, but you need to use the right path or resources. It's important to trade correctly with fixed-income portfolios. The margin of error and the price movement are much less than in the equity market, so securing an advantage becomes more challenging.
Using a block desk provides the opportunity to get a better price than what’s available in the market. It doesn't guarantee a pricing advantage, but even gaining a slight advantage on a fixed-income trade can add to returns and yield over the long run.

Spreads are part of the ETF equation, and investors should have realistic expectations about spread amounts.
Spreads reflect the underlying securities—and they’re generally higher for bonds versus stocks. Creation fees and market maker profits are also components of the spread.
Market makers strive for fair, efficient pricing, but there may be opportunities for improvement. Leveraging the right resources, including the block desk, may help tighten the spread. It may not always happen, but it’s worth a try, particularly with larger trades.

Active management and portfolio turnover generally do not have an impact on an ETF’s tax efficiency. A portfolio’s tax efficiency really depends on the portfolio manager’s efforts at mitigating gains throughout the year.
Portfolio managers can take small losses throughout the year. That way, when a manager exits an appreciated security, the portfolio already has some losses built in to offset the gain.
Portfolio managers can also take advantage of redemptions as they occur, ridding the portfolio of low-cost-basis securities.

American Century offers seven fixed-income ETFs. We also have a convertibles securities ETF and a preferred securities ETF.
Our seven fixed-income ETFs focus on multisector income, corporate bonds, core intermediate bonds, core short bonds, municipal bonds (two strategies) and emerging markets debt.
These ETFs help investors pursue total return and income objectives.

¹ Bloomberg

June 2, 2021, call highlights

Investors keep ETF flows on record-setting pace

ETF flows topped $65 billion in May, bringing the year-to-date total to nearly $400 billion. Five months into 2021, year-to-date ETF flows are close to the record total for all of 2020, which was $500 billion.
Equity ETFs (U.S. and non-U.S.) continued to garner robust investor interest, taking in $42 billion for the month. In terms of style, the growth-to-value rotation continued. Investors poured $9 billion into value-oriented equity ETFs, bringing the year-to-date total to $37 billion. So far this year, growth equity ETFs experienced outflows of approximately $5 billion.
Flows into fixed-income ETFs remained robust, totaling $16 billion in May. Approximately 75% of the fixed-income intake favored U.S. ETFs.
ESG-oriented ETFs took in nearly $6 billion in May, bringing the year-to-date total to approximately $22 billion. Meanwhile, thematic ETFs experienced outflows for the first time this year. Commodities ETFs took in $5 billion in May, but year-to-date outflows total more than $6 billion.

This month’s focus: Dispelling ETF myths

Unlike trading volumes for individual stocks, ETF trading volumes are not good indicators of liquidity. This is largely due to the ability of an ETF to issue or withdraw shares according to supply and demand dynamics among investors.
An ETF’s underlying securities are the prime drivers of the ETF’s liquidity.
It’s important to look beyond trading volume and on-screen indicators of ETF liquidity, which usually are misleading. The volume presented on the screen indicates what already has traded, not what could have traded. Bottom line: ETFs are liquid, and data on trading volumes do not indicate liquidity.

Share volume increases dramatically in lower-priced ETFs. The lower the share price, the easier it is to demonstrate high volume.
For example, the share price for a newly launched ETF can range from $10 to $100. When an investor with $10,000 to spend buys an ETF priced at $100 per share, that’s a volume of 100 shares. But spending that same $10,000 on an ETF priced at $10 per share yields a volume of 1,000 shares.
NAV plays a huge part in ETF volumes, particularly when higher-priced ETFs compete against ETFs with share prices at the lower end of the spectrum. While it appears higher-priced ETFs have lower volumes, it’s really the actual dollars traded that matter.

Expecting the highest return from an ETF with the lowest expense ratio in a particular asset class isn’t a sound long-term approach. Instead, investors should select ETFs with investment strategies that match their financial goals.
Consider the value equity strategy. Value ETFs have different takes on what constitutes “value.” Some look at value through the lens of dividends. Others give larger weightings to more value-oriented sectors, such as utilities or consumer staples, or focus on “deep value” stocks.
Each value methodology involves specific costs and creates different outcomes. And those outcomes further depend on the market climate and all the various components of an investor’s total investment portfolio. These factors are much more pertinent to long-term performance than the ETF’s expense ratio.

ETF managers can pull many different levers to minimize capital gains in their portfolios.
Most redemptions happen in kind, which means the low-cost-basis securities will exit the portfolio. So, the ETFs cost basis is always being reset.
There's always an opportunity for a portfolio manager to rebalance and build up losses in the portfolio to offset any gains, regardless of the turnover activity.
All ETF sponsors can leverage some form of creation/redemption mechanism associated with the rebalance of their underlying index. This absolves the fund from distributing the gains and instead allows investors to realize those gains when they decide to sell shares.

In general, fixed-income ETF managers can leverage similar tax tactics as equity ETF managers, though the process within fixed-income ETFs is more complicated.
Given recent interest rate movements, many fixed-income ETFs likely have embedded capital gains. But similar to equity managers, bond managers can leverage different tools to offset those gains.
It’s important to remember there's nothing in the ETF structure versus the mutual fund structure that eliminates taxation of bond income. But trading management within a bond ETF versus a bond mutual fund can create tax efficiencies from a capital gains perspective.

ETFs with higher average daily volumes do not necessarily have higher spreads. Most ETFs are priced according to the liquidity of the underlying securities rather than trading volume.
For example, the average spread in the large-cap universe is somewhere between $1.25 and $1.75. Market makers need to add in hedging and other costs, meaning a typical large-cap security tends to be three- to five-cents wide. Spreads among other security types tend to be modestly wider.
Overall, spreads remain fairly competitive. Market makers do an excellent job of keeping them all close, regardless of volume.

May 5, 2021, call highlights

ETF flows remain on record-setting pace

Investors poured $74 billion into ETFs in April, bringing the year-to-date total to $325 billion. For all of 2020, a record $500 billion flowed into ETFs.
Every category other than commodities experienced inflows in April. For the first four months of 2021, flows into equity ETFs already exceeded the total amount of equity ETFs inflows in 2020. The large-cap equity category alone took in $120 billion year to date.
Flows into investment-grade fixed-income ETFs totaled $15 billion in April and $41 billion year to date. In April, all fixed-income ETFs except long-maturity and corporate bonds experienced inflows.
We’re still waiting for the SEC to weigh in on two key issues facing the ETF industry: launching Bitcoin ETFs and expanding semitransparent ETFs to asset classes other than U.S. equities.

This month’s focus: Biden’s $6 trillion policy agenda

With the first piece of President Joe Biden’s legislative agenda—the $1.9 trillion American Rescue Plan—passed in March, investors are examining the next two components. We expect a lot of political horse trading to occur between now and when the final versions are up for vote.
The American Jobs Plan (AJP), which calls for $2.3 trillion in infrastructure and other spending funded by corporate tax hikes, will equal 1% of U.S. GDP each year of the bill’s eight-year lifespan. Approximately half the spending is aimed at traditional infrastructure, including road and bridge repair, electrical grid upgrades and water system improvements. The other half targets broad issues, such as home health services, job training, broadband access and clean energy initiatives.
The $1.8 trillion American Families Plan (AFP) includes significant tax hikes to fund programs such as free preschool and community college and subsidized daycare.

While it’s unclear what provisions of the proposed AJP and AFP will appear in the final bills, the tax implications—particularly from the AFP—will have the largest impact on investors.
The proposed taxes—from higher individual rates to new treatment of inherited assets—will make financial and estate planning challenging as Congressional negotiations unfold.

The AFP calls for raising the top marginal tax rate from 37% to 39.6%. Currently, the top rate kicks in at annual income of $628,300 (married couples). Under the AFP, the top tax rate will apply to annual income of $400,000 and higher.
The AFP also significantly raises the long-term capital gains tax rate for certain investors. For those with incomes of $1 million or more, the capital gains tax rate will climb from the current 23.8% to 43.4%, both of which include the 3.8% net investment income tax.
Under the AFP, the 3.8% net investment income tax will now apply to those earning $400,000 or more, including those generating income from partnerships and S corporations.
The plan also calls for imposing capital gains tax on inheritances, eliminating the stepped-up basis and taxing the inheritance at the asset’s original purchase price. The plan allows for a maximum $1 million exemption per person on the capital gain.

The existing $500,000 capital gains exclusion on a married couple’s principal residence remains.
The AFP limits like-kind exchanges, which allow real estate investors to defer capital-gains taxes when they swap properties. The bill caps the benefit at $500,000.
The bill also calls for taxing carried interest as ordinary income rather than capital gains.

The current version of the plan does not remove the federal cap on state and local tax (SALT) deductions.
The Tax Cuts and Jobs Act of 2017 limited SALT deductions to $10,000—a point of contention for higher-income taxpayers in high-tax states.
Some Democrats from high-tax states claim they won’t support the AFP unless the bill repeals the SALT cap.

Higher capital gains tax rates should enhance the attractiveness of ETFs broadly, given that ETFs are tax-efficient vehicles and tend to minimize capital gains.
Higher tax rates generally lead to increased demand for tax-exempt municipal bonds. Furthermore, along with their tax-free income, municipal securities aren’t subject to the net investment income tax. Conversely, stocks and corporate bonds are subject to the tax.
The Biden plan includes the largest capital gains tax hike in history, making it difficult to gauge investors’ response. Also, it’s unclear how this provision—or any of the bill’s other taxes—will fare during Congressional negotiations. We’ll continue to monitor developments to understand how the plan ultimately will affect specific investment vehicles and client strategies.

April 7, 2021 Call Highlights

Small-cap and value were first quarter’s leaders

In the first quarter, small-cap stocks significantly outperformed large-cap stocks, while value stocks outpaced growth stocks.
An interesting anomaly emerged during the quarter. Typically, low-quality stocks underperform the broad market. However, low-quality stocks have recently outperformed high-quality stocks. We think stimulus has helped fuel this performance, but it’s a trend we’ll closely watch, given our ETFs’ focus on quality characteristics.
Among core bonds, rising rates led to negative first-quarter performance. High-yield bonds, which are less-sensitive to rate movements than investment-grade securities, delivered gains for the quarter, underscoring the importance of active management to take advantage of opportunities.

ETFs Experienced Record-Setting Flows

A record $240 billion in new assets flowed into ETFs during the first three months of 2021. This represents nearly 50% of the new assets that went into ETFs for all of 2020.
Most of the quarter’s new assets went into equity ETFs, and nearly half of the equity flows went into U.S. equity ETFs. Despite the challenges of rising rates, flows into fixed-income ETFs were positive.
Value-focused ETFs gained $25 billion in assets, while growth ETFs lost assets. Additionally, TIPS ETFs gained $8 billion in new assets. TIPS ETFs historically have seen low flow levels. More than $16 billion in new assets went into ESG ETFs, reflecting growing momentum in these strategies.

Active ETFs Showed Strongest Growth

While active ETFs comprise only 3.5% of the $5.9 trillion U.S. ETF market, their growth rate is the industry’s highest. Over the last three years, active ETFs have grown nearly 50%. In 2020, active ETF launches outpaced index ETF launches for the first time—thanks largely to the introduction of semitransparent ETFs. American Century Investments was the first to offer these products.
March marked the one-year anniversary of American Century’s launch of the industry’s first semitransparent active ETFs. The introduction of semitransparent ETFs marked the first time a new domestic equity ETF structure captured $1.5 billion in assets in its first year.
Demand for active ETFs remains strong. Year to date through March, 71 ETFs have launched, 51 of which are active portfolios. While semitransparent ETFs are currently only available in the domestic equity asset class, we expect the new SEC commissioner to set the tone for the next expansion.

In a transparent active ETF, all holdings are visible all the time. Semitransparent ETFs maintain some level of transparency—enough for market makers to quote prices and promote fair and efficient markets and for investment managers to protect their proprietary strategies.
No matter the specific structure of a semitransparent ETF, what really matters is these portfolios shield some or all of their specific holdings from daily disclosure. This allows the portfolio manager to put forth the best portfolio without any fears of front running or free writing.

In 2020, 56% of all equity mutual funds paid capital gains, while only 3% of equity ETFs paid capital gains. Among transparent ETFs, active ETFs generally do not pay more capital gains than passive ETFs.
Since their March 2020 launch, American Century’s four semitransparent ETFs have not paid capital gains. We believe this is the mark of skilled portfolio management. Of course, this doesn’t guarantee they won’t pay capital gains in the future.
Unlike passive ETFs, active ETFs can employ tax-loss harvesting strategies and other tactics to enhance overall tax efficiency.

March 3, 2021 Call Highlights

February ETF flows were strong

Nearly $96 billion flowed into ETFs in February, the second-largest monthly amount on record. February’s flows brought the year-to-date total to $151 billion. For all of 2020, flows slightly surpassed $500 billion. Some pundits believe ETFs will take in a record $600 billion in 2021.
Most of the new money went into equity ETFs—$59 billion into U.S. equity ETFs and $26 billion into non-U.S. equity. Within the equity asset class, value ETFs had positive flows, while growth ETFs experienced outflows. Thematic ETFs took in $12 billion in February.
Fixed-income ETFs took in nearly $7.5 billion in February, including $2.8 billion in TIPS ETFs, reflecting investors’ growing concerns about inflation.

In their search for yield and stability, ETF investors are favoring investment-grade fixed income. Year to date, all fixed-income flows have gone into investment-grade portfolios. High-yield ETFs have experienced outflows.
In terms of maturity, investors have generally favored short-maturity bonds over intermediate-maturity bonds. But both categories have experienced positive flows.

Volatility tends to prompt investors to move money around, thus creating spikes in trading volumes. Trading volumes also tend to increase after index rebalancings.
We recommend waiting approximately 15 minutes after the market opens to initiate trades. We also suggest avoiding the last five to 10 minutes of any trading day.
In volatile markets, it’s important to examine the liquidity of the ETF’s underlying securities. For less-liquid securities, such as preferreds and convertible bonds, spreads can remain wider than normal for up to 30 minutes after the market opens—particularly when volatility is heightened.

Efficient trading can help a portfolio, while poorly executed trades can hurt a portfolio. You want to leverage the control and keep the control with you, which is why we recommend using limit orders—even with smaller trades. We recommend setting limit orders at the ask price or a little bit above the ask.
If you put a limit order at the bid, you're saying you want to buy the shares at a price that somebody is willing to sell. The moment you go inside the ask with a price you want to pay, you become the bid, waiting for one of two things to happen. You're waiting for somebody to sell you shares, or you're waiting for the underlying securities to fall below the price market makers believe reflects the underlying liquidity. And some ETFs have more liquidity than the underlying securities because they trade so much. But 60% to 65% of all ETFs trade fewer than 50,000 shares a day.
For larger share purchases—say 1,000 shares or more—you’re counting on enough sells to fill that order. To lessen this risk and ensure you get the securities, you need to eliminate the ask, by setting the price at least a penny above. This will help you purchase the securities while controlling the price.

When trading large blocks of shares—5,000, 10,000 or more—it makes sense to leverage a block desk to get the best execution.
With a block desk, you have the opportunity to execute a larger trade than what the market makers are willing to do at the ask price. And every time you can do better than the ask price, you're actually improving your client's long-term total return.
If you have questions about trade execution, reach out to your American Century representative, who will put you in touch with our capital markets desk. It's a helpful resource available to all our clients.

Trading a semitransparent ETF is no different than trading a traditional ETF. Similar to traditional ETFs, we recommend waiting at least 15 minutes after the market opens before trading.
When buying a smaller lot of shares, we recommend using a limit order and setting the purchase price a penny above the ask price. When buying a larger number of shares, we suggest using a block desk.
The platforms have built up the block desks to really help you get the best execution, whether it's a small volume ETF or a small asset ETF. The market makers have done enough of these trades to realize where liquidity is and how they have to compete for price, even though they don't know the specific holdings.
Among American Century’s transparent active ETFs, even though we don't see the holdings every day, they're still trading very efficiently. They have fairly consistent spread levels based on what is within the underlying exposures.

Instead of prices, it’s important to look at the spread related to price. On the surface, a $25 product with a 4-cents spread looks to be a better value than a $50 with a 7-cents spread. But when the market maker converts the relationships to basis points, the $25 per share ETF actually has a wider spread.
It’s also important to remember that cash flows in and out do not affect share price. The performance of the underlying securities is the only factor affecting share price.
Given the structure of ETFs and the way in which buys and sells are executed, there’s no drag from trading costs. While the effect may only be one or two basis points a year, it adds up over time and can enhance performance for long-term investors.

February 3, 2021 Call Highlights

ETFs start year strong

ETFs took in $56 billion in January, even as volatility soared late in the month. International equity ETFs saw the largest flows.
Thematic ETFs took in $13 billion, including more than $4 billion to energy ETFs. Within the equity category, $8 billion flowed into the value style.
Flows into fixed-income ETFs totaled $13 billion in January. Continuing the momentum from 2020, investors poured $8 billion into ESG ETFs.

Building on strong popularity in Europe, investing with an ESG lens is gaining growing acceptance in the U.S. For example, a recent study indicated 60% of Millennials are interested in investing in ESG products.
Politics is also playing a role. Fulfilling his campaign promises, President Joe Biden on his first day in office signed several executive orders altering various aspects of U.S. energy policy. Separately, GM set a goal of eliminating gas-powered vehicles by 2035. These actions are highlighting the “E” of ESG investing.
ESG has shifted from an exclusionary exercise (avoiding certain types of companies) to a driver of performance, largely due to technological advancements in select industries, such as energy.

In addition to a potential performance enhancer, ESG is often a component of the risk management process. Any of the ESG pillars—environmental, social or governance—has the potential to affect a company’s brand or reputation, making ESG important to the risk management process.
Several ESG data vendors provide information and scoring on companies’ ESG merits. Additionally, many investment managers incorporate proprietary criteria when integrating ESG into their investment process.
Broadly integrating ESG into the overall investment process is one approach investment managers may use for core portfolios. Some managers take the ESG integration further, tilting portfolios to companies with the highest ESG scores and underweighting companies with lower scores.
ESG integration can lead to thematic portfolios, such as those focusing on clean energy or low carbon companies. Generally, these portfolios would serve as a complement to an investor’s overall investment strategy.
Impact investing takes sustainable investing a notch further. In addition to investing in “good” companies (from an ESG perspective), they try to generate a measurable E, S or G impact along with financial return.

Morningstar recently purchased Sustainalytics, an ESG and corporate governance research, ratings and analytics firm. With this purchase, Morningstar offers a solid global framework for measuring companies’ ESG performance.
The website ETFs.com and Bloomberg also offer various ESG analytics and tools.
It’s important to note there are many different ESG data vendors in the marketplace, each offering a different approach. So, a company that scores well with one vendor may not score well with another. The key is figuring out which source aligns with your goals, so you can have one consistent analysis.

There are many passive equity products available, some pursuing growth or value objectives, some focusing on specific themes, and others in the impact category. But all are subject to the goals and methodology of the underlying index.
We're strong believers in active management overall, but within the ESG space, active management removes some of the reliance on vendors and their specific scoring methods. Active management also limits the focus on historical data, allowing consideration for companies the manager believes are taking valid, active steps to improve their ESG compliance. It also expands the investment universe into smaller companies the vendors may not monitor.
In the fixed-income category, it’s difficult to create indices around ESG, so all portfolios in this asset class are currently actively managed.

American Century launched two actively managed semitransparent ESG ETFs in 2020—the first to do so.
Sustainable Equity ETF (ESGA) is a large-cap core portfolio that intentionally overweights companies we believe offer the best ESG characteristics while underweighting the laggards. Mid Cap Growth Impact ETF (MID) invests in high-quality mid-cap growth companies we believe offer attractive return potential and positive impacts on society.
Many of our traditional investments also feature ESG integration, a natural evolution for American Century’s unique ownership structure. The Stowers Institute for Medical Research owns a controlling interest in American Century. Through this structure, American Century’s dividend payments ensure the ongoing support of the institute’s important work toward improving health and saving lives.

First Quarter Outlook

January 13, 2021

Edward Rosenberg, Head of ETF, and Sandra Testani, Director of ETF Product Management, start the new year with an update on the market, ETF flows and what to expect as we kick off 2021..

What Was and What Could Be

December 2, 2020

Edward Rosenberg, Head of ETFs at American Century Investments, presents a brief recap of 2020 and his outlook for the ETF market in 2021.

What Now? Post-Election Perspective

November 4, 2020

Edward Rosenberg, Head of ETFs at American Century Investments, shares thoughts on the election outcome and his outlook for the coming months.

Tips for Tax-Loss Harvesting

October 7, 2020

Edward Rosenberg, Head of ETFs, provides a brief update on the market, ETF flows and the dos and don’ts of tax-loss harvesting.

What's Driving the Industry Shakeout?

September 2, 2020

Edward Rosenberg, Head of ETFs at American Century Investments, provides a brief update on the market, ETF flows and what’s behind the low number of launches and high number of closures.

Looking Under the Hood

August 11, 2020

Edward Rosenberg, Head of ETFs, shares a brief update on the market, ETF flows and what’s behind the low number of launches and high number of closures.

2020 Half-Time Report

July 1, 2020

Edward Rosenberg, Head of ETFs, shares a mid-year update, reviews the big trends in 2020 and shares what we are watching for in the second half.

The ETF Revolution Continues

June 2020

This year marks a new milestone for the ETF universe. Asset flows tell us clients are increasingly incorporating ETFs into their portfolios to get the exposure they want. Hear from Head of ETFs, Edward Rosenberg, as he shares his thoughts on the markets, recent changes to the ETF landscape and expanding ETF investing opportunities

Reimagining ETFs

American Century Investments® and Avantis Investors™ bring you ETF solutions with distinct expertise

ETF Overview

Exchange Traded Funds (ETFs) are bought and sold through exchange trading at market price (not NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions will reduce returns.

IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

Exchange Traded Funds (ETFs): Foreside Fund Services, LLC - Distributor, not affiliated with American Century Investments Services, Inc.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

IRS Circular 230 Disclosure: This communication was written in connection with the promotion or marketing, to the extent permitted by applicable law, of the transaction(s) or matter(s) addressed herein by persons unaffiliated with American Century Companies, Inc. American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, to the extent this communication contains any discussion of tax matters, such communication is not intended or written to be used, and cannot be used, for the purpose of avoiding tax penalties. Any recipient of this communication should seek advice from an independent tax advisor based on the recipient's particular circumstances.

This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.

ETFs Unscripted

June 8, 2022, call highlights

ETF flows rebound in May1

This month’s focus: An index is an index, right?

Returns can vary widely

Keep style differences in mind

Know the risks of market-cap strategies

Alternative indices can focus on fundamentals

Understanding rebalancing schedules

Edward Rosenberg

Sandra Testani, CFA, CAIA

May 11, 2022, call highlights

Investors exited ETFs in April1

This month’s focus: ESG Strategies

DEMOGRAPHICS DRIVING GROWTH

A FRAMEWORK FOR UNDERSTANDING THIS SPACE

ENGAGEMENT/ACTIVE OWNERSHIP APPROACH

COMMON CRITICISMS OF ESG

April 6, 2022, call highlights

Flows stronger than in February1

This month’s focus: Actively managed ETFs

TWO-YEAR ANNIVERSARY OF SEMITRANSPARENT ETFS

TRANSPARENT ACTIVE ETFS

WHY TRANSPARENT ACTIVE ETFS MAY MAKE SENSE IN TODAY’S MARKET

March 9, 2022, call highlights

Russian invasion/heightened market volatility

Flows improved in January1

This month’s focus: ETFs and taxes2

Tax-Loss Harvesting

TAX BENEFITS OF THE ETF STRUCTURE

CAPITAL GAINS AVOIDANCE

February 9, 2022, call highlights

Flows slow to start 2022*

This month’s focus: Rates, inflation and volatility fuel heightened uncertainty

Uncertainty and the bond market

Uncertainty and the stock market

The resurgence of inflation

January 12, 2022, call highlights

ETF 2021 flows hit new record1

This month’s focus: 2022 outlook

1. Interest in Environmental, Social, Governance (ESG) and sustainable investing is growing

2. Active ETFs will gain ground

3. Inflation and Fed policy will create headwinds for certain assets

4. Focusing on quality and valuations remains prudent

December 8, 2021, call highlights

ETF year-to-date flows approach $800 billion*

This month’s focus: Key ETF themes in 2021

Growing interest in/acceptance of active ETFs

ESG goes mainstream

Taxes and tax efficiency

Soaring inflation

The rise of the retail investor

November 11, 2021, call highlights

ETF year-to-date flows outpace last year’s record run1

This month’s focus: Defining quality

What’s a quality factor portfolio?

What does quality mean at American Century Investments?

How does the process differ depending on the portfolio?

October 6, 2021, call highlights

ETF flows remain on record-setting pace1

This month’s focus: What indices can and can’t do for you

What are the limitations of equity indices?

What about fixed-income indices?

Is index construction objective or subjective?

September 1, 2021, call highlights

August ETF flows remained robust1

This month’s focus: ETFs and Taxes

What is tax-loss harvesting?

Are capital gains avoidable?

Why aren’t capital gains in ETFs higher?

How important is portfolio construction to tax liability?

August 4, 2021, call highlights

Year-to-date ETF flows surpass 2020’s record level1

This month’s focus: Fixed-income ETFs

What makes fixed-income ETFs attractive?

Why are active strategies more prevalent among fixed-income ETFs than equity ETFs?

Bonds generally are less liquid and don’t trade as frequently as stocks. Is that a concern for trading fixed-income ETFs?

Why are spreads wider on fixed-income ETFs than stock ETFs?

Does active management, and the resulting turnover, affect an ETF’s tax efficiency?

What fixed-income ETFs does ACI offer?

ETF flows rebound in May¹

Investors exited ETFs in April¹

Flows stronger than in February¹

Flows improved in January¹

This month’s focus: ETFs and taxes²

ETF 2021 flows hit new record¹

ETF year-to-date flows outpace last year’s record run¹

ETF flows remain on record-setting pace¹

August ETF flows remained robust¹

Year-to-date ETF flows surpass 2020’s record level¹