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Actively managed exchange-traded funds are a growing trend in the investing world.
So far, investors have been pulling money out of active mutual funds in recent years, looking instead for actively managed ETFs. Investors withdrew about $2.2 trillion from active mutual funds from 2019 to October 2024, according to Morningstar. At the same time, they added about $603 billion to active ETFs.
According to Morningstar, active ETFs experienced positive annual inflows from 2019 to 2023 and are expected to achieve positive inflows in 2024. Meanwhile, active mutual funds have lost money in all but one year (2021); through the first 10 months of 2024, they lost $344 billion.
“We view (active ETFs) as a growth engine for active management,” said Bryan Armor, research director for North American passive strategies at Morningstar, while acknowledging that
“It’s still early days,” he said. “But it’s a bright spot in an otherwise gloomy market.”
At a high level, mutual funds and ETFs are similar.
They are legal structures that hold investors’ assets. But experts say investors have begun to favor ETFs in recent years because they generally enjoy a cost advantage over mutual funds.
Why fees matter
Actively managed fund managers actively select stocks, bonds or other securities that they expect to outperform a market benchmark.
This type of active management typically costs more than passive investing.
Passive investing used in index funds doesn’t require fund managers to do much real work, and they essentially replicate the returns of market benchmarks like the S&P 500 U.S. stock index. Therefore, their fees are usually lower.
According to Morningstar, the average asset-weighted expense ratio for active mutual funds and ETFs is 0.59% through 2023, compared with 0.11% for index funds.
Data shows that active managers tend to perform worse over the long term than peer index funds after taking fees into account.
For example, about 85% of large-cap active mutual funds have underperformed the S&P 500 over the past 10 years, according to data data From S&P Global.
As a result, passive funds have attracted more investor money than active funds each year for the past nine years, according to To the morning star.
“It’s been a tough few decades for actively managed mutual funds,” said Jared Woodard, investment and ETF strategist at BofA Securities.
But for investors who prefer active management, especially in smaller segments of the investment market, active ETFs tend to have a cost advantage over active mutual funds, experts say.
Experts say this is largely due to lower fees and tax efficiency.
ETFs typically have lower fund fees than their mutual fund counterparts and generate annual tax bills for investors much less frequently, Armor said.
He said that by 2023, 4% of ETFs will distribute capital gains to investors, compared with 65% of mutual funds.
This cost advantage has helped boost ETFs overall. ETFs’ market share relative to mutual fund assets has more than doubled over the past decade.
Still, active ETFs account for only 8% of total ETF assets and 35% of annual ETF inflows, Armor said.
“They represent a small portion of active net assets but are growing rapidly at a time when active mutual funds are seeing considerable outflows,” he said. “So, that’s a big story.”
Convert mutual funds to ETFs
In fact, many fund managers have converted their active mutual funds to ETFs under 2019 SEC rules allowing such activity, experts say.
To date, 121 active mutual funds have become active ETFs, according to a Nov. 18 research note from BofA Securities.
Such a switch “could curb capital outflows and attract new capital,” the Bank of America report said. “Two years before the switch, the average fund outflow was $150 million. After the switch, the average fund inflow was $500.”
That said, there are a few things investors need to pay attention to.
First, investors who want active ETFs are It’s unlikely they will receive a benefit in a workplace retirement plan, Armor said.
Unlike mutual funds, ETFs can’t attract new investors, Armor said.
He said this could put investors at a disadvantage in ETFs that employ certain “super-niche, concentrated” investment strategies because fund managers may not be able to execute on that strategy while the ETF attracts more investors.
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