The Simple Truth: A Better Mouse Trap Is Evidenced By Your Tax Bill

By Toroso Asset Management

Sometimes, simplicity adds clarity in its presentation of evidence in why we see continued growth in the ETF industry. With that in mind, this week’s message focuses on the ETF market through an analysis of the Top 10 US Equity ETFs and the ownership by the largest 10 Stocks in the S&P 500. The combined value of the 10 ETFs is about $841 Billion or 24% of the $3.4 Trillion in U.S. ETF Assets Under Management (AUM).

First, when we focus on these top 10 stocks, it is clear that only shares of Alphabet (GOOG) are above the industry average of 8.21%. This suggests that ETF ownership remains small. Second, active portfolio managers, like Capital Group and even Berkshire Hathaway (BRK), continue to be challenged by the after-tax returns provided by ETFs. Arguably active management also appear to be creating more frictional cost for their stakeholders than ETFs. Third, ETF innovation continues to be driven purely by investor needs for solutions in changing times. Fourth and last, adding insult to the market challenges in 2018, many large mutual fund platforms will be paying out huge taxable capital gain distributions. Therefore, the antiqued mutual wrapper after a 10-year bull market may be set for real vulnerability.

Top Institututional Holders

In our vision for the current global $5 Trillion AUM market, we see a 20% growth rate over the next 12 years because some of that growth will come through access to different asset classes and solutions: fixed income, core themes, broad multi-asset hedge fund alternatives, and factor-based solutions. According to the 2018 Investment Fact Company Fact Book, total global assets of worldwide regulated open-ended funds in 2017 represented about $49.3 Trillion in AUM. Looking out 12 years, it seems reasonable to see the ETF wrapper representing half of all AUMs; possibly $30 Trillion.

Alphabet (GOOG) Benefits By Dual Classes of Stock

Ownership by the Top 10 largest ETFs of the largest 10 companies (by market weight) is mostly at an average range of about 6-8%. Alphabet (GOOG) is at about 11.2% because of its dual share classes is the only exception. (More research to follow on this issue in another Toroso weekly research piece.) Noteworthy is also the fact that Alphabet is owned by 349 ETFs, including multiple different types of based factor-focused ETFs. As the chart below highlights, most of the companies are held by ETFs in the range of 208 to 268 ETFs. The point is that ownership in these large names can grow meaningfully without consequences.