Guess what percentage of ETF assets are actively managed?

The answer is 0.12%. That’s 12/100^ths of one percent. There are only 64 actively managed ETFs, and two of those (two popular PIMCO bond investments) account for over half of all of the assets. Passive ETFs account for 99.88% of the total $1.5 trillion in ETFs. The market share of actively managed ETFs is basically a rounding error. Why is this? ETFs have tax advantages over mutual funds – ETFs are taxed only when sold, while mutual funds must distribute taxable dividends and capital gains. ETFs are cheaper to operate, as investors trade them amongst themselves – no redemptions and cash management issues. Sounds like a winner. The stated reason for active manager’s “meh” attitude toward ETFs is transparency. Mutual funds (with $10.2 trillion in assets) are required to disclose the investment positions only quarterly. ETFs must disclose investment positions daily. If funds had to disclose daily, competitors could artificially drive individual security prices up or down, or even mimic the fund investor’s strategy. For more depth, click this article from The New York Times. Got it. Active mutual funds can only exist if shareholders are unaware of the securities held in the fund. And if you wanted to mimic the fund’s strategy, why not just buy the fund? I would suggest there are three other salient reasons for the paucity of active ETFs, and as usual for the Frugster, it has to do with fees and fee disclosure.

1. You can’t have share classes in an ETF. The ETF has a fee disclosure. If you want to charge a different amount for the investment strategy in the ETF, you have to have a different ETF. If you see two ETFs with identical investment strategy but different fees, you’ll choose the one with the lower costs.
2. There is no distributor acting as middleman. Buyers and sellers trade on exchanges, just as they would equities and bonds. Fund companies would be unable to control rapid trading and would be unable to levy redemption fees.
3. Most powerfully... ETF fees are fully disclosed. Let’s say Active ETF A has a total US Equity Market benchmark and Passive ETF B is indexed to that same benchmark. They compete side by side for five years. Performance and fees are fully disclosed and we get the rarely seen “apples to apples” comparison. There will be a winner and a loser.

Don’t hold your breath waiting for active management ETFs!