Investor Demand for Low Cost Funds Drives Active ETF Flows

Investor Demand for Low Cost Funds Drives Active ETF Flows

The bulk of active fund flows has been focused on lowest-fee funds, Morningstar data showed.

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Reviewed by: Lisa Dallmer
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Edited by: Daria Solovieva

Investor dollars have been pouring into actively managed exchange-traded funds, but over the last 18 months, those dollars have been overwhelmingly going to the least expensive funds. 

Active funds received 23% of all net inflows to U.S.-listed ETFs through June 30, despite making up only 5.6% of assets under management, according to etf.com and Morningstar data. Active funds have, over the long term, proved to be losers, with only a minority outperforming their indexes after accounting for fees over the long term. 

Those flows haven’t been evenly distributed, however, with 83% of them going to the active ETFs in the lowest quintile of fees, according to data from Morningstar Direct. This concentration in lower-fee active funds is part of an accelerating trend, with 69% of flows going to the bottom fee quintile in 2020, up substantially from 32% in 2021 and just 26% in 2020.  

 

Percent of Active ETF Flows Going to Bottom Fees Quintile

201820192020202120222023 (through 6/30)
55%38%26%32%69%83%

Source: Morningstar Direct

 

The difference between the equal-weighted and asset-weighted average expense ratio for active ETFs is another sign investors are flocking to cheaper funds. For ETFs traded in the U.S., the former dropped 6.6 basis points from 2017 to 2022, but the latter average dropped by 17 bps over the same period. This shows that active funds have been getting cheaper, but investors are also disproportionately choosing less expensive funds.  

 

YearEqual-Weighted Average Expense Ratio (%)Asset-Weighted Average Expense Ratio (%)
20170.7070.60
20180.6680.58
20190.6370.50
20200.6580.49
20210.6490.49
20220.6410.43

Source: Morningstar Direct

 

Morningstar’s research suggests investors looking for low-fee active funds have the right idea. Active funds have traditionally struggled to compensate for their high fees with outperformance. From 2002 to 2022, 96.9% of actively managed U.S. stock funds underperformed their benchmarks, with that number being 94.2% for international stock funds and 69.2% for general bond funds.  

“There’s plenty of data showing that fees are the biggest factor in outperformance. The lower the fees, the better chance a fund has at outperformance,” said Nate Geraci, president of The ETF Store.  

Another factor in active funds getting less expensive is the growth of funds like those offered by Dimensional Fund Advisors. While their funds are technically actively managed, they use rules-based strategies rather than traditional stock picking, in a way similar to how smart-beta ETFs operate.  

Since they don’t follow an index, they can choose when and how they rebalance to reduce trading costs. That strategy is clearly popular, having garnered over $90 billion in assets under management across 31 ETFs since late 2020. The average expense ratio for Dimensional’s funds is 0.25%, which is substantially lower than average.  

The fact that these indexlike strategies are all technically actively managed funds has pulled down average costs as well. 

 

Contact Gabe Alpert at [email protected] 

Gabe Alpert is a former data reporter at etf.com with over seven years’ experience in financial journalism. He also previously contributed reporting and analysis to Barron’s Magazine, Investopedia and other publications.