Turning the Page on 2020

Investors Forge New Patterns


On a personal level, I imagine most of us are looking forward to turning the page on 2020. The new year holds the promise of lifting our various states of quarantine as vaccines may enable us to again shake hands with colleagues and hug our loved ones without reservation.

On a professional level, 2020 may well be the year that marks a true inflection point for exchange-traded funds (ETFs). Net flows into ETFs hit an all-time record at $91 billion in November 2020, besting the previous top month by over $30 million. Overall, 2020 net flows are within striking distance of the $471 billion record set in 2017. Meanwhile, mutual funds have experienced outflows of over $300 billion, driven primarily by investors pulling assets from fixed income to shore up liquidity in the midst of market turmoil.1


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New Investing Patterns Emerge

The headline cash flow numbers are noteworthy in and of themselves. However, looking within the pattern of flows, we see several key developments impacting ETFs this year and likely for years to come:

 

ETFs Pass the Stress Test—Again

Even though ETF assets now total over $5 trillion in the U.S. and over $7 trillion worldwide, it is still common to hear concerns about ETFs’ abilities to work as intended during extreme market events. However, in March, ETFs were again tested by outsize market volatility and by nearly all accounts that successfully navigated the unprecedented and historic drawdown.

“ETFs were resilient during market stress in March 2020,” according to Investment Company Institute’s COVID-19 Market Impact Working Group .2


Typically, ETFs represent roughly 20%-25% of total U.S. stock market trading volume, but their volume spiked above 40% in March. Bid/ask spreads widened, but often less than those of underlying securities. Furthermore, bond ETFs, in some instances, became a tool for price discovery, incorporating more accurate and real-time information on pricing for thinly traded and less liquid market segments. This meant that ETFs let investors:

  • Transfer risk without impacting the prices of the underlying securities.
  • Reallocate portfolios and hedge risks quickly and efficiently.

 

Investors Look Beyond Broad Market, Index-Based ETFs

We often hear ETFs used as a proxy for broad market (i.e., beta) passive investing as the industry developed the ability over time to slice the investing universe into more and more narrow pieces by country, sector, market capitalization and so on. A quite noticeable pattern in the cash flow in 2020 has been a desire of investors to add value in their portfolios, above and beyond these simple exposures and beyond equities into fixed income. 

Active ETFs Take Hold

These ETFs first became available in 2008, but 2020 is the year they really found their footing. Assets in actively managed ETFs have grown nearly 60% from the end of 2019—up from just $100 billion at the end of 2019 to just over $160 billion today.1 Launches of new active ETFs surpassed passive launches this year for the first time on record. And of course, the milestone approval by the Securities and Exchange Commission of ETFs that limit holdings disclosure to monthly or quarterly as opposed to daily has ushered in a new wave of strategies that had not previously been available: semitransparent active, also known as nontransparent active ETFs.

Semitransparent Active ETFs Launch

American Century is proud of its place in the industry’s history with the launch of the first two semitransparent (or nontransparent) active equity ETFs (FDG and FLV) on March 31 and the first two semitransparent active, sustainable investment strategies (ESGA and MID) on July 14.

Thematic and ESG ETFs Grow

Beyond active investing, 2020 also has been a breakout year for thematic ETFs as well as Environmental, Social and Governance (ESG) ETFs. The interest in ESG ETFs is additional evidence that investors are seeking to better align their portfolios with emerging, secular trends that may be difficult to capture through traditional indices.

Bond ETFs Recognized as Critical Investing Tool

The growth of fixed-income ETFs this year may come as a surprise to many skeptics who have questioned their ability to maintain liquidity during stressed markets. Although bond ETFs experienced a modest outflow of $19 billion in March, this paled in comparison to the $270 billion investors pulled from fixed-income mutual funds that month.

So far year to date, fixed-income ETFs garnered over $194 billion in net new flows, surpassing $1 trillion in assets for the first time. In fact, fixed-income flows are keeping up with the $198 billion in flows into equity ETFs and are on pace to post the best calendar year on record.1  

Moreover, the Federal Reserve included 16 fixed-income ETFs that provide exposure to both investment-grade and high-yield bonds in its Secondary Market Corporate Credit Facility program (SMCCF) . This action shored up liquidity in the corporate bond market and cemented bond ETFs as a critical investing tool.

Looking Forward to 2021

While we remain hopeful that the pace and efficacy of vaccines will enable the markets and the economy to continue to recover next year, we recognize that many uncertainties and risks remain. We are confident that the ETF industry will continue to meet the challenges as more and more investors recognize the benefits of these low-cost, tax-efficient structures and the industry continues to innovate to provide additional solutions for investors’ portfolios.


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1Source: Bloomberg as of 12/15/2020.

2Source: Investment Company Institute. Experiences of US Exchange-Traded Funds During the COVID-19 Crisis, October 2020. https://www.ici.org/pdf/20_rpt_covid2.pdf .

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.

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.

FDG, FLV, MID, ESGA:

Traditional ETFs tell the public what assets they hold each day. These ETFs will not. This may create additional risks for your investment. For example:

  • You may have to pay more money to trade the ETFs’ shares. These ETFs will provide less information to traders, who tend to charge more for trades when they have less information.
  • The price you pay to buy ETF shares on an exchange may not match the value of the ETF’s portfolio. The same is true when you sell shares. These price differences may be greater for these ETFs compared to other ETFs because it provides less information to traders.
  • These additional risks may be even greater in bad or uncertain market conditions.
  • MID and ESGA will publish on their website each day a “Proxy Portfolio” designed to help trading in shares of the ETF. While the Proxy Portfolio includes some of the ETF’s holdings, it is not the ETF’s actual portfolio.

The differences between these ETFs and other ETFs may also have advantages. By keeping certain information about the ETFs secret, these ETF may face less risk that other traders can predict or copy its investment strategy. This may improve the ETFs’ performance. If other traders are able to copy or predict the ETFs’ investment strategy, however, this may hurt the ETFs’ performance.

For additional information regarding the unique attributes and risks of these ETFs, see the additional risk discussion at the end of this material. 

FDG, FLV:

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.

The fund is an actively managed ETF that does not seek to replicate the performance of a specified index.

This fund may invest in a limited number of companies, which carries more risk because changes in the value of a single company may have a more significant effect, either negative or positive on the fund's value.

Because the shares are traded in the secondary market, a broker may charge a commission to execute a transaction in shares, and an investor also may incur the cost of the spread between the price at which a dealer will buy shares and the somewhat higher price at which a dealer will sell shares.

The Verified Intraday Indicative Value: Unlike traditional ETFs, the fund does not tell the public what assets it holds each day. Instead, the fund provides a verified intraday indicative value (VIIV), calculated and disseminated every second throughout the trading day by the Cboe BZX Exchange, Inc. (Listing Exchange) or by market data vendors or other information providers. It is available on websites that publish updated market quotations during the trading day, by searching for the fund's ticker plus the extension .IV, though some websites require more unique extensions. For example, the VIIV can be found on Yahoo Finance (https://finance.yahoo.com) by typing "^FLV-IV" (for Focused Large Cap Value ETF) or "^FDG-IV" (for Focused Dynamic Growth ETF) in the search box labeled "Quote Lookup." The VIIV is based on the current market value of the securities in the fund's portfolio on that day. The VIIV is intended to provide investors and other market participants with a highly correlated per share value of the underlying portfolio that can be compared to the current market price. To calculate the VIIV, the fund employs two separate calculation engines to provide two independently calculated sources of intraday indicative values (calculation engines). The fund then uses a pricing verification agent to continuously compare the data from both the calculations engines on a real time basis. If during the process of real time price verification, the indicative values from the calculation engines differ by more than 25 basis points for 60 consecutive seconds, the pricing verification agent will alert the advisor, and the advisor will request that the Listing Exchange halt trading of the fund's shares until the two indicative values come back into line. This "circuit breaker" is designed to prevent the VIIV from reflecting outlier prices. The specific methodology for calculating the fund's VIIV is available on the fund's website.

Portfolio Transparency Risk: The VIIV is intended to provide investors with enough information to allow for an effective arbitrage mechanism that will keep the market price of the fund's shares trading at or close to the underlying net asset value (NAV) per share of the fund. There is, however, a risk, which may increase during periods of market disruption or volatility, that market prices will vary significantly from the underlying NAV of the fund. Similarly, because the fund's shares trade on the basis of a published VIIV, they may trade at a wider bid/ask spread than shares of ETFs that publish their portfolios on a daily basis, especially during periods of market disruption or volatility, and therefore, may cost investors more to trade. Although the fund seeks to benefit from keeping its portfolio information secret, some market participants may attempt to use the VIIV to identify the fund's trading strategy, which if successful, could result in such market participants engaging in certain predatory trading practices that may have the potential to harm the fund and its shareholders. The fund's website will contain a historical comparison of each business day's final VIIV to that business day's NAV.

Early Close / Trading Halt Risk: Trading in fund shares on the Listing Exchange may be halted in certain circumstances. An exchange or market may close early or issue trading halts on portfolio securities. In times of market volatility, if trading is halted in some of the securities that the fund holds, there may be a disconnect between the market price of those securities and the market price of the fund. In addition, if at any time the securities representing 10% or more of the fund's portfolio become subject to a trading halt or otherwise do not have readily available market quotations, the fund's advisor will request the Listing Exchange to halt trading on the fund, meaning that investors would not be able to trade their shares. Also, if there is a circuit breaker event, as described above, the fund's advisor will request the Listing Exchange to halt trading. During any such trading halt, the VIIV would continue to be calculated and disseminated. Trading halts may have a greater impact on the fund than traditional ETFs because of its lack of transparency. Additionally, the fund's advisor monitors the bid and ask quotations for the securities the fund holds, and, if it determines that such a security does not have readily available market quotations (such as during an extended trading halt), it will post that fact and the name and weighting of that security in the fund's VIIV calculation on the fund's web site. This information should permit market participants to calculate the effect of that security on the VIIV calculation, determine their own fair value of the disclosed portfolio security, and better judge the accuracy of that day's VIIV for the fund. An extended trading halt in a portfolio security could exacerbate discrepancies between the VIIV and the fund's NAV.

Authorized Participant / Authorized Participant Representative Concentration Risk: The fund issues and redeems shares that have been aggregated into blocks of 5000 shares or multiples thereof (Creation Units) to authorized participants who have entered into agreements with the fund's distributor. (Authorized Participants). The creation and redemption process for the fund occurs through a confidential brokerage account (Confidential Account) with an agent, called an AP Representative, on behalf of an Authorized Participant. Each day, the AP Representative will be given the names and quantities of the securities to be deposited, in the case of a creation, or redeemed, in the case of a redemption (Creation Basket), allowing the AP Representative to buy and sell positions in the portfolio securities to permit creations or redemptions on the Authorized Participant's behalf, without disclosing the information to the Authorized Participant. The fund may have a limited number of institutions that act as Authorized Participants and AP Representatives, none of which are obligated to engage in creation or redemption transactions. To the extent that these institutions exit the business or are unable to proceed with creation and/or redemption orders with respect to the fund and no other Authorized Participant is able to step forward to process creation and/or redemption orders, fund shares may trade at a discount to NAV and possibly face trading halts and/or delisting. This risk may be more pronounced in volatile markets, potentially where there are significant redemptions in ETFs generally. The fact that the fund is offering a novel and unique structure may affect the number of entities willing to act as Authorized Participants and AP Representatives. During times of market stress, Authorized Participants may be more likely to step away from this type of ETF than a traditional ETF.

MID, ESGA:

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.

The fund is an actively managed ETF that does not seek to replicate the performance of a specified index.

Proxy Portfolio Risk: The goal of the Proxy Portfolio is, during all market conditions, to track closely the daily performance of the Actual Portfolio and minimize intra-day misalignment between the performance of the Proxy Portfolio and the performance of the Actual Portfolio. The Proxy Portfolio is designed to reflect the economic exposures and the risk characteristics of the Actual Portfolio on any given trading day.

  • The Proxy Portfolio methodology is novel and not yet proven as an effective arbitrage mechanism. The effectiveness of the Proxy Portfolio as an arbitrage mechanism is contingent upon, among other things, the fund's factor model analysis creating a proxy portfolio that performs in a manner substantially identical to the performance of the fund's actual portfolio. While the Proxy Portfolio may include some of the fund's holdings, it is not the fund's Actual Portfolio. ETFs trading on the basis of a published Proxy Portfolio may exhibit wider premiums and discounts, bid/ask spreads, and tracking error than other ETFs using the same investment strategies that publish their portfolios on a daily basis, especially during periods of market disruption or volatility. Therefore, shares of the fund may cost investors more to trade than shares of a traditional ETF.
  • Each day the fund calculates the overlap between the holdings of the prior Business Day's Proxy Portfolio compared to the Actual Portfolio (Proxy Overlap) and the difference, in percentage terms, between the Proxy Portfolio per share NAV and that of the Actual Portfolio (Tracking Error). If the Tracking Error becomes large, there is a risk that the performance of the Proxy Portfolio may deviate from the performance of the Actual Portfolio.
  • The fund's Board of Trustees monitors its Tracking Error and bid/spread. If deviations become too large, the Board will consider the continuing viability of the fund, whether shareholders are being harmed, and what, if any, corrective measures would be appropriate. See the Statement of Additional Information for further discussion of the Board's monitoring responsibilities.
  • Although the fund seeks to benefit from keeping its portfolio information secret, market participants may attempt to use the Proxy Portfolio to identify a fund's trading strategy, which if successful, could result in such market participants engaging in certain predatory trading practices that may have the potential to harm the fund and its shareholders.

Premium/Discount Risk: Publication of the Proxy Portfolio is not the same level of transparency as the publication of the full portfolio by a fully transparent active ETF. Although the Proxy Portfolio is intended to provide investors with enough information to allow for an effective arbitrage mechanism that will keep the market price of the fund at or close to the underlying net asset value (NAV) per share of the fund, there is a risk (which may increase during periods of market disruption or volatility) that market prices will vary significantly from the underlying NAV of the fund. This means the price paid to buy shares on an exchange may not match the value of the fund's portfolio. The same is true when shares are sold.

Trading Issues Risk: If securities representing 10% or more of the fund's Actual Portfolio do not have readily available market quotations, the fund will promptly request that the Exchange halt trading in the fund's shares. Trading halts may have a greater impact on this fund compared to other ETFs due to the fund's nontransparent structure. If the trading of a security held in the fund's Actual Portfolio is halted, or otherwise does not have readily available market quotations, and the Advisor believes that the lack of any such readily available market quotations may affect the reliability of the Proxy Portfolio as an arbitrage vehicle, or otherwise determines it is in the best interest of the fund, the Advisor promptly will disclose on the fund's website the identity and weighting of such security for so long as such security's trading is halted or otherwise does not have readily available market quotations and remains in the Actual Portfolio.

Authorized Participant Concentration Risk: Only an authorized participant may engage in creation or redemption transactions directly with the fund. The fund may have a limited number of institutions that act as authorized participants. To the extent that these institutions exit the business or are unable to proceed with creation and/or redemption orders with respect to the fund and no other authorized participant is able to step forward to process creation and/or redemption orders, fund shares may trade at a discount to net asset value (NAV) and possibly face trading halts and/or delisting. This risk may be more pronounced in volatile markets, potentially where there are significant redemptions in ETFs generally. The fact that the fund is offering a novel and unique structure may affect the number of entities willing to act as Authorized Participants. During times of market stress, Authorized Participants may be more likely to step away from this type of ETF than a traditional ETF.

A strategy or emphasis on environmental, social and governance factors ("ESG") may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underperform or perform differently than other portfolios that do not have an ESG investment focus. A portfolio's ESG investment focus may also result in the portfolio investing in securities or industry sectors that perform differently or maintain a different risk profile than the market generally or compared to underlying holdings that are not screened for ESG standards.

MID is classified as non-diversified. Because it is non-diversified, it may hold large positions in a small number of securities. To the extent it maintains such positions; a price change in any one of those securities may have a greater impact on the fund's share price than if it were diversified.

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