Why RIAs and IBDs Favor ETFs Over Actively Managed Funds 4 to 1

It’s well known that ETFs have been growing in popularity, increasing market share at the expense of mutual funds, and that financial advisors are increasingly investing in ETFs on behalf of clients.  But the extent of that usage may surprise you.

According to a new report from Broadridge’s Fund Distribution Intelligence, which compiles data on ETFs and mutual funds, the use of ETFs among RIAs is undergoing a dramatic shift. While currently held assets are split 30% passive – largely ETFs – vs. 70% active (primarily actively managed mutual funds), 80% of net new cash flows are invested in passive assets vs. 20% in active assets.

Broadridge reported a similar shift in the IBD channel. Seventy-seven percent of new cash flows in that channel are invested in passive instruments versus 20% in actively managed funds.

“This has been the trend over the past couple of years but now it has accelerated,” says Frank Polefrone, senior vice president of product development at Broadridge. “It’s not just because of the DOL fiduciary rule,” which requires that advisors act in the best interest of their clients. “Even if it’s done away with or watered down, I don’t think that will change the trend.”

Underlying the trend toward passive investment, especially ETFs, and away from active investments are the lower costs, increased transparency and tax-efficiency.

But the DOL fiduciary rule, which is scheduled to take effect starting April 10 if there are no delays or a repeal under President-elect Donald Trump, has RIAs and IBDs looking at their accounts and considering what lower-cost products to switch to in order to serve the best interest of their clients. Actively traded products that cost more and underperform passive investments could be subject to class-action lawsuits under the DOL rule, explains Polefrone.

“The DOL rule hasn’t even taken effect, but it’s getting everyone’s attention.”

Lower-cost products could also potentially leave more money in the pocket of fee-based advisors. They don’t charge more for higher priced products, and since few actively managed funds consistently outperform their benchmark indexes, their clients are likely to have more assets on which to base their  fees.

“The monthly data we see is consistent with these trends,” says Todd Rosenbluth, director of ETF Research at CFRA. “”RIAs and IBDs are increasingly using ETFs for their asset allocation needs, and various iShares core product ETFs and Vanguard core products ETFs are among the biggest asset gatherers. We see inflows into IVV [iShares Core S&P 500 ETF]and VOO [Vanguard S&P 500 ETF] even when SPY [SPDR S&P 500 ETF Trust] has outflows.”

Although all three ETFs are based on the S&P 500 index, the expense ratios of IVV and VOO are about half that of SPY, just four and five basis points, respectively.