Exchange-traded funds (ETFs) have traditionally been associated with passive investment strategies, but there's been a substantial increase in actively managed ETFs recently. Analysts attribute this surge to investors seeking lower costs and more precise investment strategies. Initially, active ETFs represented just over 2% of the U.S. ETF market in early 2019. However, they've experienced annual growth exceeding 20%, achieving a market share of over 7% by 2024, according to data from Morningstar.
In just the first nine months of 2024, 328 active ETFs were introduced, following 352 in the same period in the previous year, marking a striking upswing, as noted by Stephen Welch, a senior manager research analyst for Morningstar. The ETF landscape continues to evolve with important historical insights for investors. For context, the 2019 introduction of the U.S. Securities and Exchange Commission's 'ETF rule' simplified the approval process, easing portfolio managers' ability to launch new ETFs. Concurrently, there’s been a growing preference among investors and advisors for lower-cost investment vehicles, and a noticeable shift where mutual funds are being converted to ETFs.
However, success in the active ETF market remains limited to a fraction of issuers, with the top 10 controlling 74% of assets as of early 2024. By October, only 40% of active stock ETFs managed assets surpassing $100 million. Investors are cautioned to consider the health of an active ETF, with Welch advising against those with scant assets. Active ETFs differ from their passive counterparts by enabling managers to actively attempt outperforming a specific benchmark, as opposed to merely replicating an index like the S&P 500.
Despite sharing the tax efficiencies of passive ETFs, active ETFs afford managers the ability to make tactical adjustments, potentially aiding in more adeptly navigating market volatility than a passive index might. Jon Ulin, a certified financial planner and managing principal of Ulin & Co. Wealth Management in Florida, asserts that active ETFs can offer unique strategies beyond what traditional index spaces provide. While the average active ETF fee is 0.65%, significantly lower than an average mutual fund's fee, Morningstar's April report highlighted that the asset-weighted average expense ratio for passive funds was just 0.11%.
Despite the cost advantage, potential underperformance remains a risk as many active managers fail to surpass their benchmarks. Moreover, the newer nature of some active ETFs means there is less performance history available for review.
