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In the investment world, actively managed exchange-traded funds (ETFs) are rapidly gaining attention and popularity. Recently, there’s been a notable shift where investors have moved funds away from traditional mutual funds and towards actively managed ETFs. From 2019 to October 2024, active mutual funds saw a massive $2.2 trillion withdrawal, while active ETFs enjoyed an influx of around $603 billion, according to Morningstar data.
Moreover, the trend showcases that active ETFs have experienced positive annual inflows from 2019 through 2023, and 2024 looks promising as well. Conversely, except for a brief positive shift in 2021, active mutual funds have largely experienced outflows, particularly shedding $344 billion in the first ten months of 2024.
"We view active ETFs as the growth powerhouse of active management," states Bryan Armour, the director of passive strategies research for North America at Morningstar. However, he points out, "It’s still early days for active ETFs, but they’ve been a shining success amidst a challenging market."
On a fundamental level, mutual funds and ETFs share similarities as both serve as legal entities holding investor assets. Nonetheless, ETFs have increasingly attracted investors due to their often-lower costs compared to mutual funds.
Why Fees Matter
Active fund managers meticulously select stocks, bonds, or various other securities in hopes of outperforming a market benchmark. This active approach generally incurs higher costs than passive investment strategies. Passive strategies—like those used with index funds—are straightforward, such as mirroring the performance of a market benchmark like the S&P 500. Consequently, their fees tend to be lower.
In 2023, the average asset-weighted expense ratio for active mutual funds and ETFs was 0.59%, significantly higher than the 0.11% average for index funds, as highlighted by Morningstar.
Data suggest that over the long haul, active fund managers often underperform compared to index funds, partly due to the fees involved. For instance, about 85% of large-cap active mutual funds lagged behind the S&P 500 over the past decade, per S&P Global’s analysis.
This situation has led passive funds to attract more investor money annually compared to active funds over the past nine years, according to Morningstar.
"It’s been a tough couple of decades for actively managed mutual funds," observes Jared Woodard, an investment and ETF strategist at Bank of America Securities.
For investors who favor active management—particularly in niche areas—active ETFs can be more cost-effective than their mutual fund counterparts, industry experts note. These cost advantages largely stem from lower fees and tax efficiency. Typically, ETFs come with reduced fees and generate fewer tax obligations for investors. To illustrate, only 4% of ETFs distributed capital gains to investors in 2023, compared to 65% of mutual funds.
These advantages have elevated the overall appeal of ETFs. Over the past decade, the ETF market share compared to mutual fund assets has more than doubled. Nevertheless, active ETFs currently make up just 8% of total ETF assets and 35% of annual ETF inflows, Armour notes. "They’re still a small slice of active net assets, but they’re expanding quickly, especially as active mutual funds face significant outflows," he explains. "That makes them a significant story in the industry."
Converting Mutual Funds to ETFs
Interestingly, numerous money managers have converted their active mutual funds into ETFs, thanks to a 2019 Securities and Exchange Commission rule allowing such transitions. So far, 121 active mutual funds have made this switch, according to a November 18 research note from Bank of America Securities.
Such conversions can help curb outflows and attract fresh investments. On average, funds saw $150 million in outflows two years before conversion, but post-conversion, they experienced an impressive $500 million in inflows.
However, there are some considerations for investors. Active ETFs might not be available within workplace retirement plans, creating a potential challenge. Unlike mutual funds, ETFs cannot close to new investors.
This could disadvantage investors in ETFs with highly specialized, concentrated strategies, as fund managers might struggle to effectively manage the strategy if the ETF attracts an overwhelming number of investors.
