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While the ETF industry is growing by leaps and bounds, investors’ inclination toward passive ETFs is quite remarkable. There are about 1836 non-leveraged ETFs listed on U.S. indexes with an average market-cap of $3.29 trillion and average expense ratio of 0.57%, as per xtf.com.

Among them, 900 are passively managed, followed by 740 ETFs following the enhanced strategy and 196 active funds. It is being noted that though the investment objective of active funds looks more promising, the gush of money is flowing into passive investment vehicles, as per John “Mac” McQuown, co-founder of Dimensional Fund Advisors, (ab the $550bn investment group), as quoted on Financial Times.

Inside the Increasing Interest in Passive Funds

Low Expense Ratio

The outperformance was attributed to the strong performance and a low expense ratio. Expense ratios of active funds are higher than passive funds. Low expense ratio has been instrumental lately in amassing investors’ assets. Most ETF issuers have embarked upon the fee war (read: BlackRock Slashes Fees, ETF Price War Intensifies).

BlackRock has been pretty proactive in slashing expense ratios for several products in a year. It is being said that the company took the step to give tough competition to other low-cost players like Vanguard and Schwab. As a result, the company has been witnessing strong inflows in recent quarters (read: Solid ETF Asset Inflows Boost BlackRock Earnings).

For example, BlackRock lowered fees for its S&P 500 tracking ETF, iShares Core S&P 500 (IVV - Free Report) , from 0.07% to 0.04%. The fee cut made IVV less expensive than another popular ETF, SPDR S&P 500 ETF (SPY - Free Report) , in its domain. The fund charges 9 bps in fees. However, yet another S&P 500-based ETF, Vanguard S&P 500 ETF (VOO - Free Report) , also charges 4 bps in fees (read: Buy These ETFs as BlackRock Cuts Fees).

The Financial Times article went on to explain that “BlackRock and Vanguard, the two biggest players in the passive investing world, manage nearly $11tn between them, having taken in nearly $600bn this year — the vast majority of it in ETFs and index-tracking mutual funds.”

Bull Market

Since Trump’s win last November, Wall Street has been buoyant barring some occasional slips. The global economy has been prospering, giving ways to a broad-based bull market, in which most market-linked products are trending. This in turn marred the appeal for active ETFs.

Some of the top-performing active ETFs in the last one-year frame were ARK Web x.0 ETF (ARKW - Free Report) (up 70.9%) followed by ARK Innovation ETF (ARKK - Free Report) (up 68.8%) and ARK Industrial Innovation ETF (ARKQ - Free Report) (up 56.5%).

And the top-performing passive ETFs were Guggenheim China Technology ETF (CQQQ - Free Report) (up 70.1%), Global X Lithium & Battery Tech ETF (LIT - Free Report) (up 66.1%), VanEck Vectors Rare Earth/Strat Metals ETF (REMX - Free Report) (up 61.2%), Global X Robotics & Artfcl Intllgnc ETF BOTZ (up 58.4%) and iShares PHLX Semiconductor ETF (SOXX - Free Report) (up 48.7%).

In a year, Europe-based active fund First Trust RiverFront Dynamic Europe ETF (RFEU - Free Report) (which charges 83 bps in fees) has gained 25.5% (as of Nov 17) while the passive fund Vanguard FTSE Europe ETF (VGK - Free Report) (which charges 10 bps in fees) has added 25%.

If performances of passive ETFs are on par with (or even better than) the active ones, why will investors flock to active ETFs at higher charges?

Quantitative Strategies of Passive ETFs

Several passive ETFs are factor-based and use quantitative strategies. In line with the article published on Financial Times, we also believe that such strategies make passive ETFs more active and position them better to pick the right stock.

Downside of Transparency in Active ETFs

One of the major drawbacks of actively managed ETFs is the obligation of the disclosure of daily portfolio holdings, which run the risk of enabling “front-running” of portfolio trades. This means that the revelation of stock holdings will give the issuer’s competitors or other investors a chance to cash in on advance information (read: Will Active ETFs Rule Ahead?).

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