In Active vs Passive ETF Debate, a Range of Opinions

As active exchange-traded funds surge in popularity, financial advisors are finding themselves torn: Should they recommend clients invest in low-cost and reliable passive, or index funds, or spend extra for those that add layers of management trying to beat broad markets? 

Actively managed ETFs landed nearly one-third of all new ETF money so far this year as of mid-June, a near-doubling of their market share, as declining prices draw in more investors. The surge comes despite evidence showing that active funds, which are more expensive because they pay a manager to beat the market, are largely unable to beat markets. 

Financial advisors are divided on whether to recommend passive, active or a mix of both. A range of new, specialized active funds, such as those that target specific outcomes or aim at particular industries or investing themes, have increased their appeal. 

“Active investing helps find opportunities that many people are unaware of. It allows you to amplify positions and profits,” Steve Oniya, CFP, of OM Investments in Houston, told etf.com in an email. He says he’s a proponent of both active and passive. 

Robin Giles, CFP, of Apex Wealth Management in Katy, Texas, said passive funds have a cost advantage since they follow an established index, and sounded a note of caution about active: 

"Passive funds are cheaper and move in line with their area of the market." Active tends to be more expensive, and sometimes the funds don’t move as expected." 

30% Into Active 

Thirty percent of fund flows so far this year have gone into active ETFs, which make up only 6% of total ETF assets, according to data from Bloomberg. That’s up from 17.5% of flows through the same period last year, according to Deborah Fuhr of ETFGI.  

Most of the new money went into active equity ETFs; despite making up less than 5% of total assets under management, actively managed funds received 56% of 2023 flows.    

Active funds typically charge fees of 0.30% to 0.70%, and can easily range higher with more specialized offerings. For example, the $1.54 billion First Trust Tactical High Yield ETF (HYLS) charges a 1.27% fee. Expense ratios for passive ETFs typically range from about 0.03% to 0.20%. The biggest ETF, the $417.9 billion SPDR S&P 500 ETF Trust (SPY), charges 0.09% 

In May, active ETF assets grew 2.5% to $392.3 billion, a small segment of the overall $6.9 trillion ETF market, according to Cerulli Edge, a newsletter of the Boston-based researcher. 

Even as the active portion grows, divisions remain among financial advisors. 

"Active ETFs have one disadvantage in that they have no mechanism to limit the size of the managed portfolio," Angela Palacios, CFP, partner and director of investments at Center for Financial Planning of Southfield, Michigan, said in an email. 

Palacios added that in smaller asset classes, that mechanism can make management difficult. "Often in areas like small company investments, it is very important that the manager have the capability to turn off fund flows to prevent becoming too large and having to reach to bigger companies to deploy the assets managed."  

Others say a blend of active and passive brings clients the best of both worlds. Ashley Folkes, CFP, and managing partner of Inspired Wealth Solutions, in Hoover, Alabama, prefers to mix and match elements within a portfolio to yield better returns for his clients.  

“Why not use an active/passive approach, which combines passive ETFs with active ETFs?” he told etf.com in an email. “After determining the asset allocation, passive ETFs are typically used for broad market exposure to take advantage of longer-term market returns with lower costs than most active ETFs.” 

By carefully monitoring the allocations in active and passive ETFs, he added, skilled fund managers can “generate consistent outperformance net of costs.” 

Active ETFs, like all investments, strive to beat the market, but often fall short. According to a June Wall Street Journal article, in which the authors examined six asset classes, it declared a clear winner: "In all but one category, passive ETFs deliver a higher post-tax return than active, and that can add half a percentage point a year in returns to an investor’s portfolio." 

Follow Michelle Lodge on Twitter @lodgemich