Morningstar - Q2 2023 - 18

Dispatches
EXHIBIT 1
Investors Shift From Active Mutual Funds to Index ETFs ...
$200B
Active Mutual
Funds
Index-Tracking
ETFs
-200
-400
01/2013
Source: Morningstar Direct.
01/2016
01/2019
12/2022
Many mutual funds have done away with these
charges in the past few decades, but they
are still levied in some instances. Another layer of
mutual fund expenses comes from 12b-1 fees
that are largely paid out to middlemen that provide
investors with access to those funds. ETFs get
around these middlemen by listing on an exchange,
which makes them available to any investor
with a brokerage account. U.S.-listed ETFs almost
never have 12b-1 fees tied to them, so their
expense ratios are largely composed of the fees
charged for managing the strategy.
EXHIBIT 2
But Active ETF Launches Have Surged
400
300
200
100
2003
Source: Morningstar Direct.
2006
2009
2012
2015
2018
2022
In response, active managers cut fees and are
moving into ETFs. In many instances, the
fees tied to the latest breed of actively managed
ETFs are now lower than their mutual fund
predecessors, and they possess the same tax
efficiency as their index-tracking counterparts,
inching them closer to the standard set by
index ETFs. The benefits once among the primary
motivating forces to move into index-tracking
ETFs are on their way to becoming table stakes in
an increasingly competitive environment.
ETFs continue to take in record flows. Monthly
net flows into actively managed mutual
funds started to turn negative in mid-2015.
Between July 2015 and December 2022, almost
$2 trillion walked away from actively managed
U.S. mutual funds.
By comparison, ETFs have consistently hauled
in new money, with almost all of those flows going
18
Morningstar Q2 2023
into index-tracking ETFs. At least part of the
reason rests with the advantages the ETF structure
has over mutual funds. All else equal, ETFs
typically cost less and make fewer capital gains
distributions. Not only are they cheaper, but
they're also more tax-efficient.
ETFs have lower fees for two main reasons. First,
they don't carry front-end or back-end loads.
As a result, the lower fees and taxes tied to
ETFs are becoming less of the differentiators that
they were in the past, meaning the underlying
investment process and the people tasked
with overseeing it have become more important in
selecting great ETFs for the long haul. As the
barriers between index-tracking ETFs and actively
managed funds continue to erode, the
emphasis should shift to the Morningstar pillars
that differ the most across investment
strategies: the process used to select stocks and
All else equal, ETFs also have a built-in
tax advantage over mutual funds. The in-kind
redemption mechanism that allows ETFs
to track their target indexes throughout the day
allows ETFs to purge shares with built-up
capital gains. Assuming potential capital gains
are managed effectively, most ETFs will
seldom have to make taxable capital gains
distributions; their mutual fund counterparts
must distribute those gains in the year
they are incurred. ETF investors must still pay
taxes when they sell their ETF shares, but
they can defer those sales and the associated
taxes to a date of their choice.
Active ETF Launches
Estimated Net Flows
Morningstar - Q2 2023

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