Will ETFs Cause Mutual Funds to Be Extinct?

Mutual funds, like dinosaurs, might be roaming the capital markets with their sheer size, but exchange-traded funds (ETFs) might be preparing their active fund counterparts for extinction.

Per an article in ThinkAdvisor, “While mutual funds may still dominate the U.S. market, ETFs are gaining traction quickly. According to the 2019 Investment Company Institute Factbook, at the end of 2018, the U.S. domestic mutual funds market amounted to $17.7 trillion in total net assets. At the end of 2018, US domestic ETFs had $3.4 trillion in total net assets, which is double the assets in ETFs from just five years ago. Index domestic equity ETFs are attracting one and a half times the net inflows of index domestic equity mutual funds since 2009. Clearly, ETFs have become very popular investments in a rather short period of time and are continuing to grow.”

Passive funds have been receiving inflows like manna from the heavens when compared to active funds, but what’s causing this dichotomy? According to research from the S&P Dow Jones Indices, performance by the majority of large-cap funds is lagging the S&P 500 for the ninth consecutive year.

A number of financial advisors are trumpeting the benefits of passive funds—their relative cost with respect to performance and thus far, that’s been the case. Additionally, active funds have not been able to strut their stuff when it came time to volatile markets.

An active fund’s ability to shift and reallocate investments during a market drawdown have been a major selling point, but unfortunately, there’s not been much to sell lately.

“The figures highlight that heightened market volatility does not necessarily result in better relative performance for active investing,” the report noted.

“What’s different about 2018 was the fourth quarter volatility,” Aye M. Soe, a managing director at S&P and one of the authors of the report, told CNBC. “Active managers claimed that they would outperform during volatility, and it didn’t happen.”

In addition, this isn’t a one-off study by S&P. The study has been ongoing for 16 years running now and thus far, the proof is in the pudding—passive funds have been able to outperform active funds in the long term

After 10 years, 85 percent of large cap funds underperformed the S&P 500. In addition, after 15 years, almost 92 percent are trailing the index.

“Over long-term horizons, 80 percent or more of active managers across all categories underperformed their respective benchmarks,” the report concluded.

As such this has been causing active funds to go asunder. In the past 15 years, over 50 percent of active funds have either been merged or liquidated—in equities and fixed income.

The disappearance of funds remains meaningful,” the report noted.

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