The Rise of Active ETFs: Where the Money Is Going
ETFs are no longer shorthand for passive investing.
Key Takeaways
ETFs have experienced strong and steady inflows over the decade and are continuing the trend in 2024.
Active ETFs build on passive ETFs' benefits but can potentially add value or reduce risk relative to traditional indices.
The momentum seems clearly behind active ETFs as more investors seek the benefits of the structure and innovation within it.
In the 31 years since their introduction in the U.S., exchange-traded funds (ETFs) have grown to represent over $9 trillion in assets across over 3,300 individual funds.1 Like mutual funds, ETFs provide a way to diversify portfolios through a basket of individual securities. Beyond diversification, ETFs also offer the potential for several other key benefits:
Low fees
Tax efficiency
Trading flexibility
Price and/or holdings transparency
More than $900 billion flowed into ETFs in 2021, a high-water mark to date (Figure 1). In contrast, mutual funds have posted outflows for four of the past six years, including losses of almost $960 billion in 2022, over $500 billion in 2023 and almost $4 billion in the first quarter of 2024.
While mutual funds overall still represent the larger pool of assets today, net flows in recent years clearly have significantly favored ETFs.
Figure 1 | Flows Have Favored ETFs in Recent Years
Data as of 3/31/2024. Source: Morningstar Direct Asset Flows Module (excludes Fund Of Funds).
Active ETFs: Building on the Benefits of Passive
For decades, ETFs were synonymous with passive-based investing as the vehicle was initially restricted to index tracking strategies. Over time, the structure and types of ETF offerings have evolved to include active management. Today, there are many different asset classes and investment styles for investors to tailor their portfolios.
Active ETFs build upon the benefits offered by passive ETFs. But in addition to the structural features of an ETF, active managers offer investment strategies that seek the potential to add value or reduce risk relative to traditional indices.
Active ETFs have grown from $112 billion in 2019 to $663 billion by the end of May 2024—a five-year annual growth rate of over 40%. ETFs have experienced strong and steady inflows over the decade and are continuing the trend in 2024.
Over the last few years in particular, active ETFs have experienced significant growth:
In 2022, approximately 15% of flows into ETFs, $90 billion, were directed to active ETFs despite active ETFs representing only 5% of the assets.
In 2023, 21% of flows into ETFs, $125 billion, went to active ETFs representing only 6% of the assets.
Through May 2024, active ETFs accounted for over 31% of flows—over $100 billion in absolute terms.
Why Active, Why Now?
There are likely many reasons for the spike in active ETF demand, but three that we believe have contributed the most are:
Desire for professional insights and risk management amid heightened market volatility and uncertainty.
Diversification from well-publicized concentration risks within U.S. large and mega-cap equity indices.
Demand for high-quality active offerings now available from well-regarded, experienced investment managers.
How Investors Use Active ETFs in Portfolios
We see clients using active ETFs much like they use passive ETFs: as core holdings, as satellite positions to complement existing passive index-tracking allocations or to express specific investment views or themes.
Active ETFs are also used to manage downside risk or volatility, as active ETFs provide the flexibility to quickly adjust exposures based on a change in market outlook or economic conditions.
Of course, active ETFs may employ the same tax management strategies that make passive vehicles appealing to investors, such as tax-loss harvesting.
A Look Ahead: ETFs Rewriting Record Books?
Several industry trends point to a bright future for ETF market share:
Product design of active strategies in the ETF wrapper continues to level the playing field with mutual funds by offering lower fees and the probability of lower capital gains as well as alpha potential.
Outflows from mutual funds going to ETFs continue.
Future conversions of mutual funds to ETFs.
The possibility of an active ETF share class on the horizon can further support asset managers' transition to the ETF business.
What’s more, active ETF product development continues to outpace passive ETFs and active mutual funds, offering investors more choice and the potential for tax efficiency and attractive costs. Ultimately, the benefits of the structure and innovation within it should attract more investors looking for new building blocks in their portfolio construction.
Source: FactSet as of January 31, 2024. Out of 328 overall issuers and out of 279 active issuers, respectively.
Authors
Head of ETF Product and Strategy
Unthink ETFs™ With American Century Investments®
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Asset and flow data as reported by Morningstar Direct as of 03/31/2024.
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