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Active ETFs seeing inflows as investors ‘want somebody minding the store’ in downturns: Expert

VettaFi Financial Futurist Dave Nadig joins Yahoo Finance Live to break down the investor inflow trends boosting active ETFs in 2023.

Video Transcript

SEANA SMITH: If you are looking to invest in the stock market and you don't want to buy a specific stock, you may turn to a mutual fund or an ETF, an Exchange Traded Fund. Now, the two share many similar characteristics. They both represent a basket of stocks or bonds, and as a result, are both typically viewed as less risky than when you choose to invest in a single stock.

Both are managed by fund managers, but that's about where some of those similarities stop. Mutual funds have been around since 1920s. ETFs, they're relatively new in comparison. The first SPDR S&P 500 ETF, ticker SPY, that launched in January of '93.

So here's the advantage over mutual funds when it comes to ETFs. ETFs can be bought and sold throughout the trading day compared to mutual funds, which can only be purchased at the end of the trading day.

There are two main types of ETFs that we want to talk about, active and passive. So passive ETFs typically track an index here, and the portfolio is updated periodically. On the flip side, you have active ETFs, and like their name implies, actively managed by their investment managers. As a result, investing in active ETFs has had a slightly more human touch, and so far this year, it seems like that is what more and more investors are wanting to see. More investors are pouring their money into active ETFs this year than they did last year in 2022.

So let's talk about all of this. For that, we want to bring in Dave Nadig. He's VettaFi's financial futurist for this week's ETF report brought to you by Invesco QQQ. And Dave, I think there's lots of questions about the popularity-- rising popularity of these active ETFs. What's driving that? What do you think?

DAVE NADIG: Well, historically this has been an index-only business, right? You mentioned the first ETFs were all index based. We didn't really get any active ETFs until PIMCO brought out BOND, their active bond ETF. And even then, most of the assets just sat there for about 10 years. It's really only been in the last year and a half or so that we've seen any real interest in active ETFs.

This year so far, we're looking at about close to 40% of the flows. Last year was already a big year. We got up to close to 14% of the flows. That was already the biggest year we'd ever seen for active, up from about I think 8% or 9% the year before. So clearly this is a story of investors slowly coming to this realization that active may have a place in their portfolio.

DAVE BRIGGS: Why? Why the transition?

DAVE NADIG: Well, a couple of things. One is we just had a big down market. So when you have a big down market, two things happen. One is people lose their conviction a little bit, right? They may have been in an index strategy. They just saw themselves take a haircut. Maybe now they want somebody minding the store. That's a phrase we hear all the time from financial advisors. I want somebody minding the store when the interest rates go crazy or whatever. So there's a piece of that.

The other big thing is we just went through a big tax-loss-harvesting season. A lot of folks who were in maybe underperforming funds, whether they were active or passively managed, mutual fund or ETF, took the opportunity to sell and book a loss. When they were coming back into the market in 2023, increasingly in the equity space in particular we've seen a real interest in finding either individual portfolio managers or teams of portfolio managers to run that money. Whether or not it's going to work, you never know.

SEANA SMITH: Dave, the ETFs that are attracting the most amount of money when it comes to the active ETFs, what are they and why do you think those ones in particular?

DAVE NADIG: So they're actually fairly traditional stock-picking active managers. Two that I'd highlight would be CGGR from the Capital Group Growth Fund of America. Most folks know that fund by name. CGGR has been beating its core benchmark, which would be the S&P 500, by about-- I think about 4% or 5% so far this year already just in the last few weeks, few months. And as a result, it's pulled in a couple hundred million dollars while the complex of S&P 500 index ETFs has actually seen $10 billion flow out in just eight weeks. So clearly that's a real reallocation we're seeing.

DAVE BRIGGS: Given the language from the Fed-- we heard some officials talking today about, you know, a 25, could be a 50, holding until middle of '24. Does that lend itself to one or the other?

DAVE NADIG: Well, I think it lends itself for people questioning their allocations, and any time that happens, there's a couple-- like I said, there are a couple of things that happens. One is that choice of-- that conviction shakes, but the other is you start looking for what could I have done better, right? If rates are now going to be 50 or 75 bips and I don't know what to do about that, finding a seasoned portfolio-management team at least may make you sleep better at night.

Now historically, we know the track record for active as a class is not actually that great. Last year was better than many years in the past, but still only about 45% of active managers managed to beat their benchmark last year, and that was a great year.

DAVE BRIGGS: Dave Nadig, excellent information, sir, as always. Great to have you in studio.

DAVE NADIG: Thanks for having me.

DAVE BRIGGS: Thank you, my friend.

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