Active management is being fueled by exchange-traded funds (ETFs).

• In recent years, there has been a shift in investor behavior, with money being added to actively managed exchange-traded funds, while active mutual funds are seeing a decrease in investments.
• Experts said that ETFs have cost advantages, such as lower investment fees and greater tax efficiencies, which is a major reason for their popularity.

Actively managed exchange-traded funds are a growing trend in the investment space.

In recent years, investors have shifted their preferences from actively managed mutual funds to actively managed ETFs. Specifically, they have withdrawn approximately $2.2 trillion from active mutual funds from 2019 to October 2024, while simultaneously investing about $603 billion in active ETFs.

Active ETFs experienced positive annual inflows from 2019 to 2023 and are projected to have positive inflows in 2024, while active mutual funds lost money in all but one year (2021), with a total loss of $344 billion in the first 10 months of 2024.

"We view [active ETFs] as the driving force behind active management growth," stated Bryan Armour, director of passive strategies research for North America at Morningstar, while acknowledging their importance.

""Despite being in the early stages, it has been a positive aspect in a gloomy market," he stated."

At a high level, mutual funds and ETFs are similar.

ETFs have become increasingly popular among investors due to their cost benefits compared to mutual funds, experts noted.

Why fees matter

Active fund managers choose specific securities with the expectation of outperforming the market benchmark.

This active management generally costs more than passive investing.

Index funds use passive investing, which involves replicating the returns of a market benchmark like the S&P 500 U.S. stock index. This requires less hands-on work from money managers and results in lower fees.

In 2023, the average asset-weighted expense ratio for active mutual funds and ETFs was 0.59%, while index funds had an expense ratio of 0.11%, according to Morningstar data.

Studies indicate that, over the long term, active managers underperform their peer index funds, after adjusting for fees.

Over the past 10 years, data from S&P Global shows that 85% of large-cap active mutual funds underperformed the S&P 500.

For the past nine years, more annual investor money has been attracted to passive funds than active funds, according to Morningstar.

Jared Woodard, an investment and ETF strategist at Bank of America Securities, stated that the past two decades have been challenging for actively managed mutual funds.

Active ETFs can be more cost-effective for investors who prefer active management, especially in specialized investment areas, according to experts.

Experts said that the main reason for the popularity of mutual funds is due to their lower fees and tax efficiency.

ETFs typically have lower fund fees than mutual funds and produce fewer annual tax bills for investors, according to Armour.

He stated that in 2023, 4% of ETFs distributed capital gains to investors, while 65% of mutual funds did the same.

Over the past decade, the ETF market share relative to mutual fund assets has more than doubled, thanks to such cost advantages.

Armour stated that active ETFs account for only 8% of overall ETF assets and 35% of annual ETF inflows.

"At a time when active mutual funds have experienced significant outflows, a small but rapidly growing portion of active net assets is gaining attention," he stated. "This is a significant development."

Converting mutual funds to ETFs

Experts said that many money managers have switched their active mutual funds to ETFs due to a 2019 SEC rule that permitted such conversions.

According to a Nov. 18 Bank of America Securities research note, 121 mutual funds have been converted into ETFs.

According to a Bank of America note, converting funds can stem outflows and attract new capital. Specifically, two years before converting, the average fund saw $150 million in outflows. However, after converting, the average fund gained $500 million of inflows.

That said, there are caveats for investors.

It is unlikely that investors who desire an active ETF can find one within their workplace retirement plan, according to Armour.

Unlike mutual funds, ETFs cannot shut down to new investors, according to Armour.

ETFs with "super niche, concentrated" investment strategies may put investors at a disadvantage, as money managers may struggle to execute the strategy effectively as the ETF gains more investors, according to him.