Rosalind Evans
Exchange-traded funds (ETFs) are often associated with passive strategies that track major market indexes. However, in recent years, actively managed ETFs have surged in popularity. As more investors seek precision and cost savings, experts emphasize these funds’ benefits—and challenges. Stephen Welch, a senior manager research analyst at Morningstar, calls this growth “kind of remarkable.” But how do you determine if active ETFs fit your portfolio well?
A Rapid Rise in Active ETFs
Active ETFs were a small part of the U.S. ETF market, making up just 2% at the start of 2019. Yet, these funds have grown by over 20% annually, now holding more than 7% of the market in 2024, according to Morningstar. This surge reflects a significant shift in the ETF landscape.
In 2024 alone, 328 new active ETFs were introduced by September, showing a rapid pace compared to the 352 launches in all of 2023. “The growth of ETFs this year has been kind of remarkable,” Welch stated, emphasizing the sustained momentum.
Factors Fueling the Growth
The U.S. Securities and Exchange Commission (SEC) played a key role in this expansion by issuing the “ETF rule” in 2019. This policy streamlined the approval process, making it easier for portfolio managers to launch new ETFs, Welch explained.
In addition, investors and financial advisors have increasingly favored low-cost investment options, leading to a shift from mutual funds to ETFs. Some mutual fund providers have even converted their funds into ETFs, further accelerating the trend.
However, success in the active ETF market has been uneven. As of March 31, 2024, the top 10 issuers controlled 74% of all assets, highlighting the concentration of success among a few players. Additionally, only 40% of active stock ETFs have surpassed the $100 million asset mark, Morningstar reported.
Evaluating Active ETF Health
When considering active ETFs, Welch urges caution. “The biggest thing to focus on is the health of an active ETF,” he advised. “Stay away from ones that don’t have a lot of assets,” as smaller funds may be less stable.
Active vs. Passive ETFs: Key Differences
While passive ETFs track major indexes like the S&P 500, active managers aim to outperform a specific benchmark. According to Jon Ulin, certified financial planner and managing principal at Ulin & Co. Wealth Management, these funds offer unique advantages. “Active ETFs allow managers to make tactical adjustments, which may help navigate market volatility more smoothly than a passive index,” Ulin explained.
Active ETFs also provide “more unique strategies” compared to traditional index funds, he added, making them attractive for investors seeking tailored approaches.
Weighing Costs and Potential Drawbacks
Active ETFs tend to be more affordable than mutual funds, with average fees around 0.65%, which is 36% cheaper than the average mutual fund fee. In comparison, passive ETFs had an asset-weighted expense ratio of just 0.11% in 2023.
However, Ulin noted some risks: “There is the potential for underperformance, as many active managers fail to beat their benchmarks.” Additionally, newer active ETFs may not have enough performance data for investors to assess long-term success.
Active ETFs offer promising advantages, including cost savings, tax efficiency, and tactical flexibility during market fluctuations. However, investors need to carefully evaluate the health of these funds and be mindful of the risks of underperformance. As Welch pointed out, it’s essential to “stay away from ones that don’t have a lot of assets.” Whether active ETFs align with your portfolio depends on your investment goals and risk tolerance.
