Record inflows. Record fund launches. Record assets. If active money management is in decline, someone forgot to tell the ETF industry.
Amped up by a meme-crazed market and emboldened by the success of Cathie Wood’s Ark Investment Management, stock pickers are storming the U.S. exchange-traded fund universe like never before—adding a new twist in the 50-year invasion from passive investing.
Passive funds still dominate the industry, but actively managed products have cut into that lead, scooping up three times their share of the unprecedented $500 billion plowed into ETFs in 2021 (as of early August), according to data compiled by Bloomberg. New active funds are arriving at double the rate of passive rivals, and the cohort has boosted its market share by a third in a year.
“Historically, people have thought about ETFs as being indexed-based,” said Todd Rosenbluth, head of ETF and mutual fund research at CFRA Research. “Then Ark became a household name, and then investors came to realize that not only were those products worth looking at, but so were others.”
None of this is supposed to happen in an industry built on the magic of indexing. Yet a market roller coaster brought on by the pandemic is helping discretionary asset managers turn ETFs to their own advantage.
Equity conditions in general have become conducive to an active approach, leadership shifting in a stop-start economy, an unpredictable macro backdrop, and increased market breadth. At the same time, investors are showing an unusual willingness to make concentrated bets, from riding the meme-stock madness to following the kind of thematic vision laid out by Wood.
“At the end of day, the ETF is just a wrapper; it’s just a way to package and distribute an investment strategy,” said Ben Johnson, director of global ETF research at Morningstar. “More investors are getting hip to the fact that the notion of an actively managed ETF is not an oxymoron.”
Today, the passive juggernaut is slashing industry costs, opening up investing to the masses and forcing discretionary traders to adapt or die. Active launches may be booming, but the bulk of cash flooding U.S. stocks is still destined for big, cheap funds that do nothing but track the market.
“Active ETFs are doing better than they have in [the] past, but passive is still king,” said James Seyffart, an ETF analyst for Bloomberg Intelligence. “A lot of that active flow in the big months from late 2020 to early 2021 is to Cathie’s funds.”
Critics say the rapidly swelling index industry is blowing bubbles in stock markets, weakening corporate governance and more. And in some ways, it can also hit returns.
“Index funds systematically buy high and sell low,” wrote Rob Arnott and his Research Affiliates colleagues in a June paper.
The main advantage stock pickers enjoy over their passive peers is more flexibility in deploying their cash. But it was a rule change in 2019 that paved the way for the current jump in activity because it made launching ETFs easier and enabled new structures that could hide the strategy underpinning a fund. That helped lure multiple major Wall Street players to the industry after years of holding out, including the likes of Wells Fargo and T. Rowe Price.
“We’re going to see the percentage of assets in actively managed ETFs continue to climb higher,” said Rosenbluth at CFRA. “They’re going to continue to have the opportunity to punch above their weight.”