Why ETFs are the Driving Force Behind the Expansion of Active Management

Actively managed exchange-traded funds (ETFs) are gaining popularity among investors as a preferred choice over active mutual funds. Data from Morningstar shows a significant shift, with around $2.2 trillion being withdrawn from active mutual funds between 2019 and October 2024, while approximately $603 billion was invested into active ETFs during the same period.

Bryan Armour, Morningstar’s director of passive strategies research for North America, sees active ETFs as the future of active management. Despite it being early days, this investment option is showing promise in a volatile market.

While mutual funds and ETFs share similarities, the latter has been more appealing to investors due to its cost benefits. Active fund managers who select specific stocks or bonds they believe will outperform the market typically charge more than passive investing. However, ETFs generally offer lower fund fees than mutual funds and produce less frequent annual tax bills for investors.

This cost advantage has contributed to ETFs’ growth, with their market share relative to mutual fund assets more than doubling in the past decade. Still, active ETFs only account for 8% of total ETF assets and 35% of annual ETF inflows, indicating that while their growth is rapid, they still represent a small portion of active net assets.

Interestingly, the Securities and Exchange Commission’s 2019 rule has allowed money managers to convert their active mutual funds into ETFs, a move that 121 funds have already made. This shift can help stem the outflow of capital and attract new investment. However, there are limitations, particularly for those seeking to invest in active ETFs through their workplace retirement plans.

In summary, while active ETFs are a growing trend in the investment world, it’s important for potential investors to understand their limitations and benefits before making a commitment. This investment option offers cost advantages and has shown strong growth, but it’s still in its early stages and represents a small portion of active net assets.

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