Why Active ETFs Are Soaring in Popularity Amid Upheaval

Turbulent markets are helping at least one section of the market—active exchange traded funds (ETFs). Passive funds still dominate the industry, but active ones are gaining in popularity. Last year saw record amounts of investor cash flow into actively managed ETFs comprised of stocks and bonds, while inflows into index-tracking ETFs slowed for the first time in over five years. “The human element of active ETF management is appealing to investors who are getting skittish when markets are volatile,” Todd Rosenbluth, director of ETF and mutual-fund research at CFRA, told the The Wall Street Journal.

Bull Market for Active ETFs

•  $27.5 billion flowed into active stock and bond ETFs last year.
• Inflows into index-tracking ETFs slowed for the first time since 2013.
• $74 billion flowed into strategic beta funds, a type of active–passive hybrid.

Source: The Wall Street Journal

What It Means for Investors

In calm markets, the high fees associated with actively managed funds tend to be a deterrent for investors. But as market volatility spikes, which it has over the past year, jittery investors appear to be willing to fork over the extra cash for more professional management of their investments.

ETFs, which track a particular market index or sector of the market, have traditionally always been seen as passive investment vehicles in contrast to mutual funds. However, ETFs are increasingly being seen as vehicles for active management as well, and while more expensive than their passive versions, can be much cheaper than actively managed mutual funds.

The mix of relative cheapness and volatile markets are making active ETF funds a new investor favourite. Annual surveys conducted by Brown Brothers Harriman indicate that a broader group of active ETFs currently top the lists of desired investments for U.S. investors and advisers. The number of active ETFs added to the market was more than the additions from any other category.

Actively managed ETFs have also been outperforming passive ones. As of mid-December, passively managed ETFs had returned a negative 6.5% for the year while actively managed ones returned negative 3.74%, according to Yahoo Finance.

Looking Ahead

Whether or not active ETFs will continue to outperform is another matter. The late Jack Bogle, legendary investor and founder of Vanguard Group, theorised that because you can’t consistently beat the market, investors could do themselves service by just passively tracking an index of the market rather than trying to one-up it. For most of the past decade that’s been good advice. Active managers will have to outperform for more than a year to prove that their fees are worth paying for.