Chart of the Week – October 14, 2024: Actively managed sustainable ETFs on the rise

Observations:

• According to an article that appeared last week in The Wall Street Journal, the assets of exchange-traded funds (ETFs) have increased from about $1.5 trillion to more than $10 trillion over the last decade. Most of the assets are managed in index funds, having attracted institutional and retail investors who sought to benefit from market tracking performance as contrasted to active management that fails in most cases to beat the market, low fees, including lower trading costs, tax efficiency, transparency and the capacity to trade these funds on an intraday basis.
• In recent years, however, an increasing number of managers have been launching actively managed ETFs. So far this year, according to Morningstar, active fund launches have outnumbered passively managed funds by more than three to one. The WSJ notes that this ratio was roughly the other way around back in 2014.
• Actively managed sustainable ETFs have also been gaining traction. At the end of 2021, there were 52 actively managed sustainable funds with $4.2 billion in net assets versus 140 passively managed ETFs with $112.5 billion in net assets, or 3.6% of assets. At the end of September of this year, assets sourced to actively managed sustainable funds increased to $10.4 billion across 84 funds that accounted for 9.3% of sustainable ETFs, or an increase of 32 funds and $6.2 billion, versus 153 passively managed ETFs but a decline of $11.1 billion in assets.
• The largest funds among sustainable ETFs remain index tracking funds, however, at least two actively managed ETFs now exceed $1.0 billion in assets. These include the BlackRock US Carbon Transition Readiness ETF (LCTU) with $1.2 billion in net assets and Dimensional US Sustainability Core 1 ETF (DFSU) also with $1.2 billion in net assets. Their advisors, BlackRock Fund Advisors/BlackRock International and Dimensional Fund Advisors, along with Franklin Advisors/Putnam Investment Management, dominate the actively managed sustainable ETF space. These three firms manage $6.6 billion in actively managed ETF assets or 63% of the total.
• In each instance, this is taking shape even as active management fails to beat the market. According to the just published S&P SPIVA report to June 30, 2024, a scorecard that compares the performance of active equity and fixed income mutual funds against their benchmarks over different time horizons, 57% of all US large-cap actively managed funds failed to beat their benchmark during the twelve-month period to June 30, 2024. This number goes up to 86% and 77% over the trailing three- and five-year time intervals. In the fixed income sphere, fewer funds underperform. For example, less than 50% of US general investment grade funds failed to beat their benchmarks over the previous twelve months while 36% and 61% failed to do so in the last three and five years. Moreover, actively managed sustainable ETFs charge an average of 56 basis points (bps) as compared to 37 bps, on average, levied by passively managed sustainable ETFs.
• That said, active management is beneficial in segments of the market that are less efficient, such as small cap stocks, emerging markets or fixed income investments, where active managers can exploit market inefficiencies by identifying undervalued or overvalued securities, or specialized investment strategies that require in-depth research and expertise, such as sector-specific funds, thematic investing, or ESG-focused investments that can more precisely align portfolios with specific investment preferences and risk tolerance.