Citi Analysts See ETFs Gobbling $21 Trillion of Mutual Funds

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(Bloomberg) — The $21 trillion U.S. mutual-fund industry could consist mostly of ETFs within the next 10 years, according to Citigroup Inc.

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Investors have favored exchange-traded funds, lured by the industry’s ultra-low fees and tax advantages. That trend remains in motion in 2021. ETFs have absorbed $387 billion since the end of December, while mutual funds have taken in $87 billion, according to Investment Company Institute and Bloomberg Intelligence data.

Citigroup sees the growth of active strategies, such as Cathie Wood’s suite of Ark Investment Management products, fueling that shift to ETFs — even as passive funds still command the lion’s share of the industry. The growing adoption of semi-transparent ETFs, which reveal their holdings once a quarter, should also help accelerate the trend, according to the bank.

“It is the beginning of the end for innovation within the mutual-fund wrapper,” Citigroup analysts Scott Chronert, Drew Pettit and Mandy Chan wrote in a note Monday. “Increasingly, we see a trend where new, innovative, equity strategies are being brought to market via ETFs, both transparent and non/semi-transparent active (NTA), instead of mutual funds.”

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Of course, assets in the mutual-fund industry still dwarf the fast-growing $6.4 trillion ETF universe. Additionally, the U.S. retirement system and 401(k)s are largely designed to integrate mutual funds.

Still, ETFs have several points in their favor that go beyond tax efficiency. The structure rarely passes along capital gains — a factor that could become even more important should the Biden administration boost that levy. Meanwhile, a long-awaited regulatory overhaul in late 2019 has ushered in scores of first-time issuers over the past year.

Granted, the bold prophecy comes from Citigroup’s ETF group. But with the likes of quant giant Dimensional Fund Advisors on the cusp of converting four equity funds into ETFs, it’s food for thought for the mutual-fund industry. The DFA conversion will be much bigger than the first and provide a benchmark of sorts for other issuers, according to Citigroup.

“Fund complexes will soon have a new point of reference for evaluating their own conversions and product offerings,” the analysts wrote.

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