From the August 2017 issue of Investment Advisor • Subscribe!

Sometimes Objects Are Not Closer Than They Appear

Identifying trends requires patience and an eye for history

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An increasingly changing world presents countless options across all facets of work and life. As much as items and routines can be set to cycle and repeat, the constant flow of information has allowed better tools and resources to become available for financial advisors, helping them sift through the noise of the squeakiest wheels. Today's media at large, including financial media, gravitates toward attracting large volumes of clicks with breaking, albeit sensational, news rather frequently. An advisory firm's business model needs to go beyond the headlines and the principal tenets of maintaining balance and patience, allowing enough time to make smart decisions and understanding that there are just no absolutes in the financial markets.

(Related: ETFs: Why They Keep Growing on Advisors)

The Investment Company Institute (ICI) consistently does an outstanding job of tracking and providing data for the fund industry, among a great number of other indispensable resources and general education that the organization offers. Among the more closely watched areas in the ETF industry, especially among ETF pundits and some more vocal observers, are fund flows into ETFs.

The Real Passive Inflows Story

For a considerable period of time, ETFs have experienced consistent inflows, whereas mutual funds have realized mostly steady outflows. One rather straightforward way to interpret this trend is to recognize an embrace of passive investing. On the other hand, this trend perhaps more strongly shows that users of passive ETFs have essentially moved active investment decisions from dedicated financial professionals to individuals who are not qualified to actively manage assets. Finally, not to discount the dedicated investment professionals who employ beta ETFs in their practice, they do so as part of their active investment process for clients.

Upon reviewing asset growth reports released in ICI's “2017 Investment Company Fact Book,” some numbers jumped out. The total assets under management of all U.S.-traded ETFs stood at $2.19 trillion in April 2016. By April 2017, the total net assets in ETFs grew to $2.839 trillion, a growth of $648 billion — certainly an impressive number.

The actual total assets story for mutual funds, however, does not exactly align with the aforementioned flows narrative. The total AUM for mutual funds checked in at $15.81 trillion in April 2016. By April 2017, the total net assets in mutual funds grew to $17.14 trillion — a huge increase of $1.32 trillion and more than double ETFs’ total growth. However, ETFs on a percentage basis continued to grow at a faster clip than mutual funds, and maintained greater inflows as previously mentioned.

The asset growth among ETFs and mutual funds can be more clearly visualized when you look at active versus passive management today. A chart posted recently by a respected industry pundit on Twitter displayed data compiled by Morningstar that charted outperformance of the actively managed large-blend category against the passively managed large-blend category. The data showed a tight battle from 1985 to 1991. Following 1991, active outperformed until 1994; then passive took over until 2000, when active took back the mantle as the leading performer from 2000 to 2011. Since 2011, passive has led active in aggregate.

A key takeaway from this data is that regardless of the stories that may lead headlines today, especially in the investment management space, very few absolutes exist and a lot of trend changes can occur. While such buzz and fodder are what make our industry so interesting, they can easily attract inappropriate attention, including that of your clients. More importantly, being cognizant of history, as well as what is populating today's industry trends and the news cycle, can help you have easier client conversations and maintain a focus on the big picture.

--- Read Schwab Expands Commission-Free ETF Offerings on ThinkAdvisor.

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