Active ETFs are poised to hit $1 billion in assets

Actively managed exchange-traded funds are poised to hit $1 billion in assets, cementing a dramatic transformation from a forgotten insulator to a key driver of global industry growth.

The vehicles, which provide a cheaper rival to mutual funds that try to beat indexes, reached $974 billion in assets at the end of July, data from consultancy ETFGI showed.

The gains mark a sharp rise in recent years for active ETFs, which have been around since at least 2006 but took until 2018 to reach $100 billion in assets, according to ETFGI data.

After US regulatory changes in 2019 accelerated launch time, active ETF assets grew at a compound annual growth rate of 48%. Globally, the number of active ETFs more than quadrupled to 2,761 over the same period. Some believe this is just the beginning.

“We’re in the early stages of growth,” said Todd Rosenbluth, head of research at TMX consultancy VettaFi. “The ETF industry will continue to grow, and active ETFs will continue to grow at a faster rate because they are newer.”

Rosenbluth added, “We have some active (mutual fund) managers who are putting the best and brightest in the business and putting their marketing efforts to meet investors where they are, which is the ETF space.”

The active ETF industry is still a fraction of the size of its mutual fund counterpart: In the U.S. alone, long-term actively managed mutual funds held $13.8 billion in assets at the end of 2023, according to the Investment Company Institute.

The direction of travel is clear, however, particularly in the US, where ETFs enjoy tax advantages over mutual funds. Actively managed domestic equity mutual funds alone have experienced net outflows of more than $2.5 billion in the U.S. over the past decade, according to ICI.

In contrast, active U.S.-listed ETFs drew a record $27.9 billion in July after previously setting highs in January and March, according to Morningstar.

Globally, active ETFs captured a record 22.4 percent share of the $665 billion in net inflows to all ETFs in the first half of 2024, according to BlackRock, accounting for 41 percent of ETF launches in the same period.

The move followed changes to regulations in some countries that only allowed ETFs to track indices.

“One of the challenges globally has been that many regulators have written regulations assuming ETFs and indexing are synonymous. They had to change the regulations to allow active ETFs to happen,” said Deborah Fuhr, founder of ETFGI.

Changes were made in South Africa, Japan and Singapore. France got the green light to list active ETFs in April, while Taiwan’s first such vehicles are expected next year after a recent rule change.

Fuhr said acceptance among investors has been helped by the arrival of JPMorgan, Fidelity and BlackRock offering active ETFs.

These industry heavyweights have large sales and marketing teams to help secure distribution deals through investment platforms.

Fuhr said regulation remains critical to how quickly active ETFs will continue to grow. A wave of fund groups have applied to the US Securities and Exchange Commission for permission to copy the ETF as the share class structure that helped propel Vanguard’s rapid expansion, the patent for which has now expired.

None of those requests have been approved so far, and even Vanguard has only green-lighted index funds. However, Fuhr said, “if this model were available for active ETFs, I think we would see significant growth.”

Active ETFs are not yet representative of the mutual fund world, however. The big success stories have been options-based strategies designed to reduce market risk – such as hedged and covered call funds – and systematic strategies that are rules-based but classified as assets.

In contrast, traditional red-blooded shareholders have been slower to embrace ETFs.

Rosenbluth believed that was beginning to change, pointing to the success of Capital Group, whose Dividend Value ETF (CGDV) has raised $10.4 billion since launching in 2022, and T Rowe Price, whose Capital Appreciation ETF One-year-old ($2.2 billion) Equity ( TCAF ) is managed by David Giroux, who also runs the $63 billion mutual fund.

However, Fuhr believed that concentrated shareholders “will be the last to move into ETFs,” given fears that increased transparency about their portfolio holdings would reveal their “secret sauce.”

One question that remains is whether or not the rise of active ETFs is good for the fund industry, given the lower fees. The average US-domiciled active equity ETF charges 32 basis points, nearly half of the 62 basis points charged by their mutual fund peers. In Europe, the respective figures are 26 bp and 112 bp.

Despite this, Rosenbluth believed that fund houses had no choice but to launch ETFs.

“Asset managers are likely to see revenue pressure as a result of this, not because they are moving into the ETF space, but as a result of investor adoption of ETFs. It is better for them to compete in the ETF industry than to try to fight it with more expensive mutual funds that investors are moving away from,” he argued.

Another question is whether or not this is good for investors, given that they would be better off buying cheap index ETFs rather than being swayed by marketing to active ETFs.

Fuhr noted that lower fees in the ETF world at least gave active managers more of a chance to beat their underlying indexes than a more expensive mutual fund would have.

Rosenbluth agreed to this. “The data is clear: it’s hard for active managers to consistently outperform an index-based approach,” he said. “But some of these funds will outperform, and equally, some investors prefer to try to outperform, and using the lower fee and more cost-effective structure of an ETF will help them more.”