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For nearly the entirety of the more than three decades in which exchange traded funds have been available to U.S. investors, those funds have been tied to passive investing. ETFs and advisor adoption of those products have undoubtedly ushered in a new era of fee-conscious passive investing and that remains true today.
While passive is likely to always be the bread and butter of the ETF business, that doesn’t diminish the potency of the active/ETF combination. In fact, ETFs, which were once seen as nails in the coffin of active management are breathing new life into this style of building portfolios. Data confirm advisors and investors are responding. Consider this nugget. At the start of 2019, US-listed active ETFs commanded just 2% market share, a figure that swelled to 8.5% at the end of the first quarter.
As advisors know, the ETF wrapper as it applies to both active and management offers advantages over traditional active open-end funds. Those include, broadly speaking , lower expense ratios and reduced capital gains distributions. Let’s be honest. If there’s one thing clients hate, it’s getting a year-end tax bill from an underperforming actively managed mutual fund. The point is ETFs, even those that are actively managed, are more tax-efficient than active mutual funds.
Those are among the reasons that over the past five years, active ETFs have garnered $375 billion in new assets while active mutual funds bled more than quadruple that amount.
Why Active ETF Growth Will Continue
One of the primary drivers supporting the growth of actively managed ETFs is the growing number of mutual fund issuers that have converted well-known funds to the ETF structure. The converted funds retain the branding and the managers that advisors and investors became familiar with, but in many cases, the converted products shed some of negatives associated with active mutual funds.
“Investors’ preference for lower-priced investments continues with active ETFs. Funds in the cheapest quintile of active ETFs hold more than $325 billion in assets, while the most expensive quintile holds just $35 billion,” notes Morningstar’s Bryan Armour. “Today’s leader, Dimensional, charges an average fee of just 0.24%, a fraction of the whole group’s 0.69%. It still pays to be cheap.”
Translation: Some mutual fund sponsors know low fees are a huge reason ETFs stole market share and when entering they hypercompetitive world of ETFs, issuers must be able to compete on price, regardless of brand awareness.
Beyond fees, active ETFs offer advisors more flexibility. ETFs don’t carry required minimum investments and, broadly speaking, they don’t close to new investors.
“Investors need to watch the size of concentrated active ETFs that play in small sandboxes. Given their lack of capacity constraints, active ETFs in large-cap categories are best suited for the ETF wrapper, although those markets are also the toughest for active managers to outperform passive peers,” adds Armour.
Opportunities Abound for Active ETF Growth
As Armour notes, just three issuers control the bulk of active ETF assets American Century via the Avantis funds, Dimensional and J.P. Morgan. That implies there’s plenty of room for other competitors to gain share in this space.
Likewise, there’s also room for asset-class expansion via active ETFs. Of the 15 largest segments by active ETF penetration today, eight are bond or options-based funds and the largest is large-cap equity blend funds. That’s relatively bland asset mix, but it’s not discouraging. However, fixed income is likely to continue to play a prominent role in the evolution of actively managed ETFs.
“Active bond ETF offerings have seen significant growth over the last few years: About 200 distinct strategies launched since December 2020, including 73 in 2023 alone, more than any other prior year. Still, the market value of active bond ETFs only accounts for about 13% of the fixed-income ETF universe,” concludes Armour.
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