One of the most common topics on Wall Street right now is active vs passive investing. According to Morningstar, in 2016 alone passive funds took in $508.4 billion, while active funds saw $340.1 billion in outflows. As hedge funds have been struggling to beat the market recently, assets in the ETF industry (roughly $4.17 trillion) have amounted to over a trillion dollars more than the hedge fund industry. Low-cost index funds and ETFs have been rapidly gaining popularity. However, we haven’t exactly seen this narrative fit in with some of the data. As Eric Balchunas of Bloomberg points out, there have actually been more new mutual funds launched this year than ETFs.
New Mutual Funds outpace - A look at Investment Costs
While index funds only make up 9% of these new mutual funds, it seems the driving factor is cost rather than vehicle. Over the past two decades, expense ratios for mutual funds of every category have fallen significantly. The bulk of the outflows from actively managed mutual funds are coming from the funds with higher costs. Meanwhile many low cost active funds such as those from Vanguard, have had cash inflows.
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With $2.2 trillion in assets tied to the S&P 500, a surprising chunk of that is in mutual funds. Considering how Vanguard's S&P 500 ETF (VOO) has an expense ratio of just 0.04%, it seems unusual that anyone would pay over 0.25% for virtually the same investment. But as Balchunas points out, there's over $50 billion worth.
Index funds have been keeping up with ETFs, as their inflows have been almost entirely driven by fees below 0.10%. In 1996, the average expense ratio for an index equity mutual fund was 0.27%, in 2016 it was 0.09%.
Finally, Balchunas points out why Wall Street fears the transition from active to passive.