The Passive Investing Tsunami in ETFs Continues

Investments have been shifting from actively managed funds to passively managed exchange-traded funds (ETFs) for a while now, but the Brexit vote and impending U.S. presidential election have fueled the migration even more. According to a recent CNBC article, the month of May saw an $18.7 billion exodus from actively managed U.S. equity funds and an $8.1 billion inflow to passively managed, index-tracking funds, primarily ETFs (data from Morningstar).

Ben Johnson, global director of EFT Research at Morningstar, believes “it’s not a question of whether the trend continues but at what pace.” The CNBC article describes the shift as occurring across all corners of the market as well as all asset classes and geographical areas. A recent survey of 283 financial advisors by the Financial Planning Association found that 83 percent were now using ETFs to invest client assets, nearly double the level of 2006.

The biggest advantage of ETFs is low cost. The average cost for passively managed funds last year was 0.18 percent versus 0.78 percent for actively managed funds (primarily mutual funds). ETFs offer more flexibility because they can be traded throughout the day, unlike mutual funds transactions which can only occur at market close. They are also more tax efficient because they don’t have to distribute capital gains to investors when securities are sold.

Thanks to the low interest rate environment, the latest opportunity for passively managed ETFs exists in fixed-income securities. Most of the money in municipal bond funds is in actively managed funds due to the widespread belief that heavy credit research better equips those managers to outperform benchmarks. But the tide is turning, and the low cost of ETFs are outweighing such perceived benefits.