Every revolution sparks a counterrevolution. And in the age of the ETF revolution, the counterrevolution is coming from active fund managers who need badly to prove the power of what they do.

Active managers have always hoped that the movement toward ETFs was mere evolution, not revolution—a mere technological innovation that added a new feature, intraday pricing, to 1940 Act index funds. Better yet, they hoped it was a fad or a gimmick.

But after another year of overwhelming inflows into low-cost beta funds, active managers know they must revive interest in what they do.

That means their value proposition needs an overhaul. To that end, they have launched new share classes with stripped-down fees—and more low-cost fund choices are on the way. The hope is that low-cost active could go head-to-head with passive.

And one type of security might help them illuminate their value proposition even more: gold ETFs, which offer a case study in how active and passive can work together rather than at odds.

Gold is an example of a market not just revolutionized but completely transformed by ETFs. Gold investors in the past had to buy coins, bullion, jewelry—physical stuff, in other words. Dealing with physical stuff means dealing with high bid-ask spreads because of the condition of the asset. Physical gold also poses a physical security risk: It’s difficult to transport and store one of the Earth’s heaviest weight-per-volume metals.

Investors who don’t like those problems have turned to futures. But the roll costs of futures can dramatically erode returns for long-term holders. 

Then along came ETFs, which offered a simple structure that could hold bullion in a secure vault. An ETF has a fixed expense ratio and defined storage parameters and locale. It trades just like any equity for a piece of metal that stays in place. Its operational simplicity makes it easy for back office accounting and record-keeping systems to manage.

And because the structure is easily available, it reveals the actual underlying investor demand for the precious metal.

That’s why ETFs have become the vehicle of choice for investors in the gold market. The total bullion held via global gold ETFs, according to data from the World Gold Council, is now 2,245 tonnes. This makes the global ETFs in aggregate bigger than all but five global central banks or international monetary institutions in terms of gold holdings.
So where does active management come in?

In equity and fixed-income asset classes, portfolio designers use performance and fees to gauge active managers and passive ETFs. But with gold, the portfolio design may be more concerned about correlation and risk metrics. Gold cares little about what other asset prices are doing, especially in times of stress, and it can alter a portfolio’s sensitivity to real rates and inflation. The metal is a hedge on the hubris of central bankers that attempt to control economic outcomes.

And that makes it a perfect topic for active managers: Gold ETFs allow them to show their worth because investors in these products need to consider more than just performance and fees. They must also consider risk metrics and inflation.

Gold ETFs thus make it an easier place to start the conversation about how active and passive work together.


Matthew Forester is chief investment officer at BNY Mellon’s Lockwood Advisors.