Active ETFs Elbowing Out Mutual Funds, ISS Says

Exchange-traded funds continue to gain market share from mutual funds and separately managed accounts, particularly among financial advisors. 

A new report from ISS Market Intelligence shows that, when given a choice among mutual funds, separate accounts and ETFs, 57% said they would invest client assets in ETFs. That’s up from 53% a year ago and 49% two years ago. 

By comparison, just 20% of advisors said they would be allocating client assets to open-end mutual funds, which is unchanged from last year and down from 28% two years ago. 

Separate accounts gained the appeal of 23% of advisors in the latest research, compared with 27% last year and 23% two years ago. 

When the data was analyzed by wealth-management channel, registered investment advisors pulled away from the pack in terms of appetite for ETFs. 

Nearly 80% of RIAs said they preferred ETFs for client portfolios, compared with 54% of regional and bank brokerage reps and 50% of representatives at the larger national brokerage firms. 

Active Management 

Among those advisors preferring mutual funds over ETFs and SMAs, the driving force is active management. 

At 50%, active management was cited as the most popular reason for using mutual funds, while diversification ranked second on the list of primary motivators at 15%. 

But among those advisors favoring ETFs, the top motivator, at 50%, were the lower fees, followed by tax efficiency at 27%. 

With active management gaining traction in the ETF industry, the report authors expect that mutual funds’ advantage will shrink in the near future. 

“It seems likely that as more active ETFs come online, any advisor preference for mutual funds is likely to diminish further because they will be able to choose from a bigger menu of active ETF options they can deploy for portfolio diversification,” the report states. 

The report lumps active management along with tax efficiency and lower fees into the “triad” of factors driving financial advisors toward ETFs. 

The potential for growth in the active ETF sector is leveraged, in some ways, by the basic demographics of the financial advisory business, which shows a greater appeal for active ETFs among younger advisors entering the profession. 

Mutual Funds Flows 

Through June this year, total active U.S. equity ETF assets was at nearly $150 billion, including $26.1 billion worth of net inflows over the first six months of 2023. Those net flows compare with $38 billion for all of 2022. 

“An advisor’s age appeared to play the most consistently significant role, with younger advisors showing higher adoption levels,” the report states. 

Among advisors between the ages 30 and 39, 24.3% expressed plans to increase their use of active ETFs, while 18.1% of advisors between the ages 40 and 49 indicated plans to increase their use of active ETFs. 

The oldest group of advisors, over age 55, reported the lowest adoption, with 17.2% in this group planning to increase their use of active ETFs. 

Contact Jeff Benjamin at [email protected] and find him on X at @BenjiWriter