The growth rate of active ETFs has been surging by over 20% annually since 2019, pushing total market share in the ETF industry to 8.5%

Morningstar, a leading provider of independent investment insights, published “Morningstar’s Guide to U.S. Active ETFs,” a new landscape report that covers advantages, challenges, approaches, and trends of actively managed exchange-traded funds (ETFs). Overall, the report found that active ETFs can be a cost-effective, tax-efficient approach to active management for investors, but as with any active investment, can carry risk over the long term.

“Active ETFs have taken center stage in the fund industry, propelled by a confluence of regulatory change, product developments, and market events that highlight the advantages of these strategies,” said Bryan Armour, director of passive strategies research for Morningstar. “After years of relative obscurity, these burgeoning vehicles could unlock opportunity for investors, while offering a lifeline to active managers in a period of significant outflows for active mutual funds.”

The rapid growth of active ETFs can be attributed to several factors: The U.S. Securities and Exchange Commission passed the “ETF Rule” in 2019, streamlining the ETF listing process and giving portfolio managers more flexibility when creating and redeeming ETF shares; investors and their advisors have increasingly sought out low-cost funds; portfolio managers have accepted greater transparency into their fund holdings, which investors have preferred; and traditional mutual fund providers began to convert existing mutual funds into ETFs to capitalize on the newfound investor demand.

The new Morningstar report delves into the benefits and drawbacks of the active ETF structure, contrasts the approaches of leading active managers, and categorizes trends and offerings for investors by asset class.

Highlights from the report include:

• Due to ETFs’ fee structure that doesn’t charge sales loads or distribution fees, the average active ETF fee is 36% cheaper than the average active mutual fund fee. As active ETFs surge, their counterparts in active mutual funds are contracting, with net outflows of $1.6 trillion in 2022 and 2023.
• The majority of active ETF assets have funneled to a few leading issuers and funds. As of March 31, 2024, Dimensional Fund Advisors leads all providers with $135 billion in assets under management, and the largest active ETF is the JPMorgan Equity Premium Income ETF.
• Asset managers can approach ETFs in different ways, such as by launching a new strategy, copying an existing mutual fund strategy, or converting a mutual fund into an ETF. The flexibility provides a growth opportunity for active ETF managers, allowing them to tailor their offerings to meet investor demand.
• Unlike active mutual funds, active ETFs cannot close to new investors, presenting a capacity risk particularly for concentrated strategies or those investing in illiquid markets. According to the report, opting for ETFs with liquid securities and diversified portfolios could help mitigate these risks.
• Fixed income was the most popular active ETF asset class early on, but active equity ETFs have since gained the upper hand because the tax efficiency of ETFs benefit equity strategies even more than bonds. Active multi-asset ETFs are few and far between since mutual funds and collective-investment trusts dominate retirement plans.

The full report can be downloaded here, and a summary article of the report can also be found here on Morningstar.com.

As the active ETF market continues to grow, Morningstar will publish ongoing analysis in its ETF Roundup article series on Morningstar.com. The topic will also be featured in different sessions at the Morningstar Investment Conference, including the session, “Active ETFs: A Lifeline or Band-Aids for Active Management?”

More information about the Morningstar Investment Conference, including the full agenda and registration details, can be found here.

Source: Morningstar