Passive versus active. It’s arguably one of the biggest debates in all of financial planning with proponents on both sides claiming their style is better. So far, the crown has continued to go towards passive and index funds. Returns for passive vehicles have long managed to outperform active managers on the whole.
It looks like times may be changing.
Thanks to the rise of active exchange-traded funds (ETFs), active management is starting to win the war. And it looks like investors are taking the hint. The latest fund flows data shows that investors – both big and small – are moving millions of dollars into these vehicles.
Big Inflows Into Active ETFs
Investors put their stamp of approval on a fund, sector or asset class in one way – fund flows. It’s the easiest way to track whether or not they like stocks or bonds, utilities or value stocks. Money flows in, and investors like it. Money goes out, and investors aren’t as big of a fan. It’s as simple as that. In this case, it looks like active management may finally be getting some love from both retail and institutional investors.
That’s the gist of some interesting data reported by institutional investor-focused Pension & Investments (P&I).
Citing ETF data provider ETFGI, P&I reports that active ETFs are quickly growing ahead of their passive rivals as investors look to limit losses and boost returns. Overall, Global ETF industry assets totaled $9.26 trillion at the end of 2022. The star of the show was active funds. Inflows to global active ETFs increased by more than 10.6% during the year to $488 billion. To put that into context, back in 2017, global active ETF assets were just a paltry $84 billion. 1
Strictly looking at the U.S., the data paints a similar picture, with inflows to active ETFs surging. According to CFRA Research, U.S.-listed active equity ETFs saw net inflows of $30 billion, which pushed assets up to $199.4 billion through May 31. For all of 2022, total flows for active U.S. ETFs were just $68 billion. 2
Proof is in the pudding. Several active ETFs have now grown in size to rival many passive funds. For example, both the JPMorgan Ultra-Short Income ETF and JPMorgan Equity Premium Income ETF hold $23 billion and $28 billion in AUM, respectively. The Dimensional U.S. Core Equity 2 ETF also holds more than $20 billion. Even after the growth meltdown, the ARK Innovation ETF still holds nearly $7.5 billion in AUM.
The Low-Cost Factor
The really interesting point to P&I’s reporting and the fund flow data is that low-cost active ETFs seem to be gathering the bulk of the assets.
ETFs grew in popularity do to their lower operating costs. Driven by rock-bottom passive funds, expense ratios for the industry have continued to decline. These days, it’s not uncommon to buy broad market exposure for 0.03% to 0.05%. This has set off a fee war within the active side of the equation.
Average expense ratios for active management have dropped as more active ETFs have launched. As of the end of 2021, the asset-weighted fee paid by investors in active funds was just 0.59%. That’s a 40% drop since 1994. Fees fell another 3% in 2022.
These days, fund flows show that investors are choosing active ETFs with expense ratios below the 40-basis point mark. For example, the previously mentioned DFA has several active funds with expense ratios of 10 basis points.
This has helped overcome perhaps the real issue with active management. We’re talking about the so-called “fee hurdle,” in which fees are directly paid out of investment gains. So, if a fund has a high expense ratio, an active manager needs to clear that before returning any extra gains to investors. Truth be told, most active managers only outperform indexes by a few basis points. Those extra basis points can and do add up over time.
But with expense ratios dropping, investors now have the ability to actually grab and earn those extra points of return. This resets the debate from active vs. passive to low-cost vs. expensive. Fund flows show that many investors have started to take the hint and move into low-cost active ETFs.
Following the Fund Flows
For retail investors and financial advisors, fund flows data shows that active ETFs are winning favor with larger investors. The key to that is low costs. With many active fund suites and ETFs now gaining critical mass, there is no need not to include them in your portfolio.
Overall, active ETFs can work in conjunction with broad passive funds, creating a core & explore model. Or they can be used to tactically add asset classes or exposures. In the end, the thing to focus on is their low costs. Those funds with low expense ratios should be able to deliver on their promise.
Top Performing Active ETFs This Year
| Ticker | Name | AUM | YTD Total Ret (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|
| ARKK | ARK Innovation ETF | $9.295B | 29.55% | 0.75% | ETF | Yes |
| DFUS | Dimensional U S Equity ETF | $6.972B | 14.82% | 0.09% | ETF | Yes |
| DFAC | Dimensional U S Core Equity 2 ETF | $21.826B | 11.03% | 0.17% | ETF | Yes |
| DFAT | Dimensional U S Targeted Value ETF | $8.807B | 7.3% | 0.29% | ETF | Yes |
| AVUV | Avantis US Small Cap Value ETF | $6.883B | 7.13% | 0.25% | ETF | Yes |
| JEPI | JPMorgan Equity Premium Income ETF | $28.955B | 5.13% | 0.35% | ETF | Yes |
| MINT | PIMCO Enhanced Short Maturity Active Exch Tr | $9.218B | 4.88% | 0.35% | ETF | Yes |
| DFUV | DFA Dimensional US Marketwide Value ETF | $9.083B | 3.76% | 0.22% | ETF | Yes |
| FTSM | First Trust Enhanced Short Maturity ETF | $7.66B | 2.95% | 0.25% | ETF | Yes |
| JPST | JPMorgan Ultra-Short Income ETF | $23.594B | 2.97% | 0.17% | ETF | Yes |
The Bottom Line
Fund flows tell the investor’s story. And right now, investors are favoring low-cost active ETFs. Ultimately, the drop in actively managed fund’s expenses has helped investors realize the extra return potential from going active with their portfolios. Regular Joes can also benefit from active management’s potential by adding a swath of active ETFs to their holdings.
1 P&I (June 2023). Low-cost, active ETFs prove to be a bright spot
2 P&I (June 2023). Managers sharpen focus of active ETFs, gain flows