Active Versus Passive ETFs: Why Lower Fees Still Win

Decades ago, there was a fierce debate on the virtues of active versus passive mutual funds. The debate has now evolved into the realm of exchange-traded funds. Which are better: active or passive ETFs? Here’s some background on the mutual fund debate before I move to the subject at hand: the ETF space.

Yesterday’s Debate: Active Versus Passive Mutual Funds

The arguments for active mutual funds were:

• Markets are inefficient, and alpha persists.
• Managers may get defensive in bad times and simply hold more cash.
• Managers can be flexible, investing in areas of the market where they have high conviction.

The arguments against active mutual funds were:

• They’re far more expensive than index funds.
• They often generate tax-inefficient capital gains for investors who didn’t sell.
• Manager risk.

Data produced by Morningstar and others was compelling: High-fee active mutual funds tended to underperform similar low-fee index funds.

Today’s Debate: Active Versus Passive ETFs

Now, with the proliferation of the ETF tax wrapper and lower fees, the traditional argument against active is far less valid when it comes to ETFs. Active ETFs are more tax-efficient than their mutual fund peers, as the creation and redemption processes can be done without pushing through capital gains for those shareholders who don’t sell. And fees for active ETFs have declined.

In a recent article, Morningstar’s Bryan Armour, director of ETF and passive strategies research for North America, wrote, “Nearly 3,000 active ETFs have been launched since the start of 2020. Net assets invested in active ETFs have grown to over $1.6 trillion from $140.0 billion.”

At the end of 2025, passive equity ETFs had an average expense ratio of 0.14%; bond index funds were even cheaper at 0.09%. This compares with 0.44% for active equity ETFs and 0.33% for active bond ETFs. The differences in expense ratios are much less than they were decades ago for active and index mutual funds. Are markets inefficient enough for active ETF managers to make up this much smaller differential in fees? Armour reports that for the trailing three years ending in 2025, active ETF success rates in besting their index peers were 50%.

One might conclude that investors are just as well off in active ETFs as a passive index ETF because half of active ETFs may continue to beat passive peers, and the tax-inefficiency problem in mutual funds has been solved by the ETF wrapper. I disagree with that conclusion.

First, I question whether half of active ETFs will continue to best passive ETFs, especially after taking into account survivor bias as unsuccessful funds are often closed. Only time will tell. But even if active keeps up with passive, variation from market performance adds additional risk, and financial theory states that investors want to be compensated for that risk. Thus, we want a higher return.

Finally, benchmarking isn’t a perfect science. Let me illustrate with bonds. Morningstar showed that 74% of active intermediate core bond funds bested their benchmarks over the three-year period mentioned earlier.

The argument is that active managers can navigate market volatility and exploit structural advantages such as credit selection and yield-curve positioning. Passive funds cannot. Supporting that argument, Vanguard once told me that as of Nov. 30, 2024, 92% of its active bond funds had bested their benchmarks over the prior five years. From the beginning of 2024 through April 16, 2026, the active Vanguard Core Bond ETF VCRB earned 10.66%, besting Vanguard Total Bond Market Index ETF BND by 1.49 percentage points. Morningstar benchmarks both funds against the same US fund intermediate core bond Morningstar Category benchmark. The core bond fund performs in the top quartile, while the total bond fund’s return has been below average.

But is this alpha? Morningstar does a great job at benchmarking, but it’s not a perfect science. While both ETFs and the category average have similar durations, they have very different levels of credit risk, as can be seen below. BND has more than 72% of assets in AAA rated bonds, while VCRB has almost 19 percentage points less. The category average is 15% in AAA bonds. Both the core bond fund and category have some junk (below BBB) or bonds that were not rated. The total bond fund essentially has none. Thus, I would argue neither the active core bond fund nor the category average is proving to be alpha. The outperformance is compensation for taking on more credit risk.

My Advice: Pay Attention to Fees and Diversification

While the active versus passive debate is important, two more important debates are high fees versus low fees and concentrated portfolios versus diversified portfolios. After all, there are narrow and expensive index funds that are far worse than low-cost and diversified active ETFs. Generally, the lowest-cost and most diversified ETFs are market-capitalization-weighted index funds with fees as low as 0.03% annually.

If you do buy active ETFs, find ones that have low fees and are diversified. Avoid expensive, flashy ETFs that can have outstanding performance and then often crash just as investors pour their money in. ARK Innovation ETF ARKK is an example that comes to mind.

My view is that active ETFs are generally better than active mutual funds but not as good as the lowest-cost and most broadly diversified indexed ETFs.