A look at the rise of active ETFs

Since the passage of SEC Rule 6c-11, also known as the ETF Rule, in 2019, the number of active ETFs available within the marketplace has seen exponential growth. The ETF Rule helped to streamline the ETF approval process, allowing more funds to come to market without the need for exemptive relief from the SEC.

One of the key aspects of the rule is the allowance for the use of custom baskets within the creation and redemption process. This provision provides managers with greater flexibility to manage an ETF’s portfolio and liquidity, particularly in markets in which the included securities may be less liquid or more difficult to access.

Since the creation/redemption process is fundamental to the unique benefits of the ETF structure, the implementation of this rule opened the door for active strategies to enter the market within a liquid, transparent, and tax-efficient structure.

Assets within active ETFs have soared

Over the last several years, assets within actively managed ETFs have soared in response to an increase in market volatility amid rising interest rates. While active ETFs currently represent only around 7% of total ETF assets, nearly a third of all ETF flows have been directed toward these types of strategies so far this year.

Source: Trackinsight, data as of 12/29/23, includes North American ETFs only and excludes other exchange-traded products (ETPs) such as exchange-traded notes (ETNs) and exchange-traded commodities (ETCs).

Advisors are increasingly interested in using ETFs

This increase in assets managed within actively managed ETFs is helped by financial advisors who are increasingly viewing ETFs as an essential component of their clients’ portfolios due to their many benefits: lower cost, transparency, liquidity, and a higher degree of tax efficiency.

A decade ago, financial advisors were allocating just under 10% of client portfolios to ETFs. Since then, the number has more than doubled, topping 20% by the end of 2023. This upward trend is expected to continue, with ETFs continuing to gain share within client portfolios.

Source: “U.S. Exchange-Traded Fund Markets 2023,” Cerulli Associates, 2023.

Recent surveys also point to a clear preference for gaining active exposure through the ETF structure. With over 80% of respondents now favoring an active strategy packaged within an ETF over a mutual fund, this reflects a significant shift in investor behavior and a notable departure from the historical dominance of active mutual funds within investor portfolios.

Source: “The Global ETF Survey 2024,” Trackinsight, 2024.

Navigating the active ETF landscape

Active ETFs offer investors the potential for alpha generation by providing access to the expertise of skilled portfolio managers who seek to outperform the market, while the benefits provided by the ETF structure can contribute to enhancing the overall portfolio management and investment experience for clients.

However, the extent of these advantages can vary widely based on a range of factors, including, but not limited to, the fund’s underlying strategy, assets under management, and trading and portfolio optimization processes. Careful selection and evaluation are essential for those who are looking to leverage the potential benefits of active ETFs for their clients.

Want to learn more about how to select and evaluate active ETFs? Read our white paper on developing a framework for active ETF due diligence.