What Would Jack Bogle Think of Single-Stock ETFs?

Exchange-traded fund launches have outnumbered those of mutual funds for the last three years in a row, and the vast majority of the action is in active ETFs.

Indeed, “it’s not hard to sniff out the money trail, and right now, the managed investment product space is pointed very firmly in the direction of ETFs as the preferred wrapper among a growing number of investors,” Ben Johnson, head of client solutions, asset management at Morningstar, tells ThinkAdvisor in an interview.

But he warns: “At the margin, increasingly, are niche, esoteric, oftentimes very volatile and sometimes super-gimmicky funds coming to market.

“They have no business [being] in most investors’ portfolio. They’re very risky in some cases,” Johnson says.

It’s no mystery that Morningstar is “focused on life after mutual funds,” as he puts it, since ETFs gathered $650 billion in net inflows over the trailing 12 months, while mutual funds saw $847.8 billion in net outflows, according to Johnson.

As of Dec. 4, there were 388 new ETFs listed in 2022 versus 150 new mutual fund launches.

Active funds represented 61% of the new ETFs, as of Nov. 30, 2022, he says.

In the interview, Johnson, who works with Morningstar’s asset management clients and their end investors, stresses that folks are gravitating toward ETFs more and more and even switching to them from mutual funds to take advantage of the former’s efficiency in “shield[ing] tax gains.”

Previously a financial advisor at Morgan Stanley, the chartered financial analyst has been with Morningstar for 17 years now, advancing from senior equity analyst to a director of ETF research to director of global exchange-traded and passive strategies research, before taking his current role.

ThinkAdvisor conducted a Dec. 12 interview with Johnson, who was speaking by phone from his suburban Chicago base.

He talked about the “huge impact” of bond ETFs on bond markets and opined on single-stock ETFs, which, he bets would have been Vanguard Group founder and “father of indexing” John Bogle’s “worst nightmare.”

Here are highlights of our interview:

THINKADVISOR: What’s the most significant news about ETFs?

BEN JOHNSON: In the market environment that we’ve lived through in 2022, we’ve seen the biggest swing in dollar terms out of mutual funds and into ETFs.

We’re generally focused on life after mutual funds. The direction where most investors’ money is going at the margin is toward some construct that is not a mutual fund.

In the [RIA] product space, we see ETFs hoovering [vacuuming] up most of the flows at the margin.

We see it in the retirement space: Mutual fund assets unpackaged and moving into collective investment trusts.

It’s not hard to sniff out the money trail, and right now, the managed investment product space is pointed very firmly in the direction of ETFs as the preferred wrapper among a growing number of investors.

ETFs would be the top vehicle of choice for advisors serving end investors and individual investors themselves building their own portfolios.

Was it less painful this down year for those who were invested in ETFs versus mutual funds?

I don’t think you can generalize. If I’m investing in an S&P 500 ETF or an S&P 500 mutual fund, my experience was effectively identical.

But what we have seen in this downturn, and have seen in similar situations, is that more investors are taking the opportunity to realize losses, or in some cases, maybe lesser gains, by liquidating positions in existing mutual fund holdings and switching to ETFs.

This has been a moment in the market where investors have been looking to realize taxable losses they can use to shield gains. They’re then reallocating that money — putting it back to work in the market.

So they’re increasingly preferring ETFs, owing in large part — especially with taxable money — to their superior tax efficiency.

To what extent are more ETFs coming to market?

We’re seeing this [same accelerating] trend in product development. Looking at new ETF launches and new mutual fund launches going back to 2020, that was the first year new ETF launches surpassed new mutual fund launches.

In 2021, it happened again, and we saw the first-ever mutual fund ETF version — so, mutual funds becoming ETFs.

[As of early December], the number of new ETF debuts outnumbered mutual fund debuts, thus far in 2022, by a factor of 2.6:1. So that trend has only accelerated.

Where do active ETFs fit in?

Active ETFs have represented the majority of ETF launches for three years running. And if you look at funds that track indexes that aren’t your father’s or grandfather’s definition of an index, you’ll include things like the KPOP ETF [KPOP], thematic funds and factor funds.

I think [only] two or three traditional index ETFs launched so far this year.

So active ETFs defined both strictly and more figuratively are really where all the new ETF launches are happening.

Some years back, many in the industry were negative about active ETFs. Please discuss the change in attitude.

A lot of portfolio managers in particular were having difficulty getting comfortable with the idea of daily ETF portfolio disclosure. They were saying, “I don’t want to be the player at the poker table that’s showing everybody my cards.” They didn’t want to give away their secret sauce.

But there’s been a growing level of comfort [because] now there’s the option to launch non- and semi-transparent ETFs. They allow portfolio managers to adhere to the same rules around disclosure that they already had for their mutual funds.

Is that why there are so many active ETFs being introduced?