If you’ve ever used a Groupon, toggled between Expedia and Kayak and Travelocity, or waited until Prime Day to do your shopping, the current state of affairs in financial services may sound familiar.
Like consumers of all types, investors are opting for discounts whenever possible, and if that means avoiding money managers who take a hands-on approach, so be it. The ratings firm Morningstar grabbed headlines this summer by announcing that the amount of assets in so-called “passively-managed” mutual and exchange-traded funds topped those that are actively managed for the first time.
Among ETFs in particular, the division is even starker: a whopping 98% of all ETF funds are passively managed, meaning they follow a pre-determined index, an imbalance that often makes it seem like “ETF” is synonymous with “passive.”
But active investors aren’t conceding defeat. As ETFs mature and the appeal of their structure becomes more accepted, fund managers will increasingly opt to use an ETF framework, rather than a mutual fund, as the backbone for their investing strategies.
There’s a lot of daylight between 98% and 2%, but thanks to regulatory changes and industry innovations, active managers who have long been eager to narrow the gap now have more ways to approach it. That could mean more choices—as well as more difficult decisions—for investors.
“I just think the pendulum has swung so far,” Catherine Wood, CEO and founder of ARK Invest, told MarketWatch in a recent interview. ARK Invest manages five ETFs focused on “disruptive innovation,” among them the Genomic Revolution ETF /zigman2/quotes/206454610/composite ARKG -3.03% and one focused on Fintech /zigman2/quotes/205650811/composite ARKF -0.43% .
“So many investors are focused on performing exactly in line with the indexes, but we see so much opportunity that’s future-oriented that’s not captured in the indexes. I think active management is going to have its day in the sun and the indexers will lag behind innovation,” she said.
Born from a crisis
To properly consider the future of ETFs, it’s important to understand their past.
ETFs were born in the aftermath of the 1987 crash known as “Black Monday.” The Securities and Exchange Commission wanted a single tradable security that represented the entire stock market to offer liquidity in the hope of preventing future market meltdowns .
“So many investors are focused on performing exactly in line with the indexes. But we see so much opportunity that’s future-oriented that’s not captured in the indexes.”
Cathie Wood, ARK Invest
The first-ever ETF, the SPDR S&P 500 fund, /zigman2/quotes/209901640/composite SPY +1.02% debuted in 1993 and is far and away the most popular ETF of any type, with nearly $275 billion in assets under management and a daily average volume of almost $18 billion, according to FactSet data.
ETFs like SPY have flourished not only because of their rock-bottom fees, but also because they outperform their more expensive counterparts.
A September report from Morningstar showed that only 23% of all active funds topped the average of their passive rivals over the past 10 years. What’s more, the cheapest funds succeeded more than twice as often as the priciest ones (33% versus 14%) during that same period.