By a margin of $8 billion, the investment industry reached a 48-years-in-the-making milestone at the end of 2023: Passive mutual and exchange traded funds in the United States overtook their actively managed counterparts in the total assets, according to recently released data.
U.S. investors had $13.244 trillion in the active funds on December 31 compared to $13.252 trillion in passive strategies, according to a report on Wednesday by Cerulli Associates, which cited Morningstar Direct data.
“Passively managed fund assets outpaced actively managed fund assets in [the second half of] 2023, growing 8.9% and 3.1%, respectively,” the Cerulli report said. For the full year, passive funds grew at a rate of 22.6% versus 10.6% for active, according to Cerulli, which had for several years predicted that passive funds would overtake active early this year.
The rise in popularity of passive funds in the United States is linked in part to two decades-long trends in wealth management: clients shifting from commission-based trading to advisory accounts and advisors migrating from traditional broker-dealers to fee-only registered investment advisory firms.
Both of those trends were “significantly impactful” to the shift from active to passively managed funds by investors, according to Matt Apkarian, an associate director of product development at Cerulli. He noted that passive funds were only around 25% of mutual fund and ETF assets a decade ago.
“Without a doubt, the RIA and the other independent channels use, and are far and away more comfortable with passive investments than active,” Apkarian said. “They believe less in the merits of active investing than the wirehouse and large broker dealer counterparts.”
A Cerulli survey of 1,500 advisors in March and April 2023 showed that RIAs allocated about 23% of their clients investments to actively managed funds, compared to 31% at wirehouses, including Merrill Lynch, Morgan Stanley, UBS, and Wells Fargo, Apkarian said.
“There is causation, this isn’t just correlated,” said Todd Rosenbluth, head of research for VettaFi, an industry consulting firm, which draws most of its clients from the RIA channel. “This is being caused in part by advisors shifting their practice to an assets under management model instead of a commission model.”
Active funds are typically more expensive and can be more lucrative for firms that accept revenue sharing payments, Rosenbluth said. RIAs, which work under a fiduciary standard, are obligated to eschew those.
The Vanguard Group, which launched the first “passive” product—an index mutual fund—in 1976, and BlackRock’s iShares have been the primary beneficiaries with 37% and 15% market shares, respectively, according to Morningstar.
But investors writ large have enjoyed the lower costs spawned by Vanguard’s innovation. Average expense ratios paid by mutual fund investors have fallen to 0.44% as of 2022, down from 0.99% in 2000, according to the Investment Company Institute’s 2023 Factbook.
“Average expense ratios (i.e., ongoing expenses) paid by US mutual fund investors have fallen substantially over time,” researchers for the wrote. “For example, on an asset-weighted basis, average expense ratios for equity mutual funds fell from 0.99% in 2000 to 0.44% in 2022, a 56% decline.”
To be sure, the data about mutual and ETF flows may slightly overstate the growing strength of passive investments, since, according to Morningstar, the statistics exclude the assets flowing into separately managed accounts (SMAs) and actively managed alternative investments—such as private credit and equity products, hedge funds, intermittent liquidity structures and non traded REITs.
Those products have become a popular alternative to active mutual funds, particularly for wirehouse brokers whose clients allocate around 22% to SMAs compared to 6% at RIAs, Apkarian said. Regional and other large independent broker-dealers also appear to be holdouts on active funds with 50% of client assets in active mutual funds, he added.
But those advisors who insist on keeping with more expensive active funds are running out of excuses to tell clients, Rosenbluth said.
“Advisors that want to keep the status quo and stay in actively managed funds are going to need to justify why they’ve chosen active management, which is more expensive,” Rosenbluth said. “Advisors will need to have an answer as to why they’re why they’re bucking the trend.”
