Index ETFs vs. Active Mutual Funds

ETF Trends

Passively managed, index-based ETFs have been slowly taking away market share from actively managed mutual funds as fed-up investors dump costly active funds that are losing to broad U.S. benchmarks.

The only reason to invest in active funds today is because the manager has a long-term track record of beating a benchmark net fees. Unfortunately, this fact alone removes most active mutual fund options.

According to a recent Evercore Pan Asset white paper titled “Passive investing for pension fund trustees,” many newly formed defined contribution schemes are catering toward auto-enrollment plans with annual fees of just 0.5%, which is impossible with high alpha managers, Money Marketing reports.

Due to the fund structure, ETFs do not have high turnovers and see low tax exposure, which help diminish fees. Consequently, ETFs have lower fees than mutual fund products – the U.S.-listed ETF universe has an average expense ratio of 0.61%. Some broad index ETFs come with expense ratios as low as 0.05%.

Large, disgruntled institutions are making the change. For instance, the California Public Employees’ Retirement System, which holds $255 billion in assets with over half already invested in passive strategies, is starting to review its active managers. [Index ETFs Chip Away at Active Fund Industry]

Retail investors have also been “voting with their feet” as funds with lower expense ratios experienced greater investor dollars over the past decade. [Cost Matters with ETFs: Vanguard Report]

“The proportion of active global, US and European fixed income managers who have beaten their benchmarks over the past 15 years is zero,” according to the white paper.

Consequently, Evercore argues that the low cost, passive ETFs are better suited to deliver market exposure.

“ETFs are predominantly the best way for us to build and manage diversified portfolios for pension fund trustees, allowing us to deliver sophisticated, dynamic strategies at two-thirds of the cost of leading off-the-shelf diversified growth funds,” according to the white paper.

For more information on mutual funds, visit our mutual funds category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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