An analysis by Morningstar examines the role that active exchange-traded funds (ETFs) play in portfolio accounts, now that the investment has swiftly expanded throughout the past years.
Morningstar attributes regulatory changes and cost-efficiency for the expansion of active ETFs. Specifically, the U.S. Securities and Exchange Commission (SEC) passed a rule in 2019 that streamlined the ETF listing process by removing “exemptive order” regulations, gave portfolio managers more flexibility in creating and redeeming ETF shares, and made it easier for managers to bring ETFs to market.
Additionally, investor and advisor demand for low-cost funds, along with the move to greater portfolio transparency by portfolio managers and the conversion of existing mutual funds into ETFs have all increased usage.
As a result, organic growth for the ETF market has exceeded 20% per year and has reached 8.5% of the total ETF market at the end of March 2024.
“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.”
Despite the growth, active ETFs still pale in comparison to the active mutual fund market, Morningstar finds. Actively managed mutual funds saw more than $13 trillion in assets by the end of 2023, at nearly 25 times more than the $530 billion claimed by the active ETF market.
Still, flow and growth rates imply that active ETFs could eventually outpace mutual funds. Therefore, fund managers would be wise to embrace the investments sooner rather than later, Morningstar suggests. They could do so by launching a new strategy, copying an existing mutual fund strategy, or converting a mutual fund into an ETF, according to the research.
Additional findings from Morningstar’s latest report includes:
- 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.
- 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.
SEE ALSO:
- Passive Funds Exceed Active Among ETFs, Mutual Funds
- ETFs, Managed Accounts Grew Rapidly in 2023
- The ‘4% Rule’ is Back: Morningstar
Amanda Umpierrez is the Managing Editor of 401(k) Specialist magazine. She is a financial services reporter with over six years of experience and a passion for telling stories and reporting news. Amanda received her degree in journalism and government and politics at St. John’s University. She is originally from Queens, New York, but now resides in Denver, Colorado with her partner. In her free time, Amanda enjoys running, cooking, and watching the latest drama show.