Once upon a time, actively managed ETFs were laughed off as an investment product with little chance of success. Fast-forward to 2023, and we find them taking the ETF industry by storm—in both their asset growth and product expansion.
Active equity ETFs this year have outpaced their passive counterparts in asset flows, taking 56% of the market share while passive took just 43.9%, according to Bloomberg Intelligence data through mid-June.
“We continue a three-year trend of more active ETFs launching versus passive,” said Douglas Yones, head of exchange-traded products at the New York Stock Exchange. Active ETFs vacuumed in $144 billion in cash flow during the first six months of 2023.
Not only has the NYSE seen a jump in active ETF listings, the exchange has also seen growth in the active proxy structure it offers for ETF managers. (Firms like American Century Investments, Charles Schwab and Nuveen are among the licensees of the structure.) By using the NYSE’s formula, ETF providers can accelerate their timetable for product launches. They can also choose between a semi-transparent or fully transparent approach for investment portfolio disclosures on active ETFs while preserving the tax benefits associated with the funds.
Advisors have traditionally used active funds in asset classes or equity categories where active managers have added alpha—such as in fixed income and high yield equity, areas where ETFs hold a high concentration of assets.
As of midyear 2023, the top three active ETFs by asset levels are the JPMorgan Equity Premium Income ETF (JEPI) with $26.9 billion, the JPMorgan Ultra-Short Income ETF (JPST) with $24 billion and the Dimensional U.S. Core Equity 2 ETF (DFAC) with $20.01 billion.
A major driving force behind the explosive growth in active ETFs is a loosening of regulatory burdens.
In 2019, the SEC adopted Rule 6c-11, also known as the “ETF Rule,” which accelerated the timetable for launching new ETFs from several years to 60 days. Besides reducing bureaucratic delays, it also significantly reduced legal costs.
Since the rule came down, the number of active ETFs has climbed from 325 to 1,071 funds, according to data from State Street Global Advisors. In other words, before the rule went into effect, it took 11 years for active managers to launch just 325 funds, while after the rule came out, 750 funds emerged in just over three years.
Another important regulatory change has allowed active ETFs to use a representative set of securities, known as a proxy, for their portfolio holdings disclosures. That means the funds don’t have to disclose all their holdings and thus become vulnerable to outsiders front-running or free riding on their trades. With that worry gone, more doors have opened for active managers to jump into the ETF marketplace.
Another big trend has been the race by mutual fund providers to convert funds into ETF structures.
Since early 2021, 46 actively managed mutual funds have been converted into an ETF format while another 16 conversions have been announced for this year. Instead of converting funds to ETFs, other firms are offering cloned versions of existing mutual funds with established track records in an ETF wrapper.
Today, active ETFs account for less than 6% of the $10 trillion of global assets invested inside ETFs. That leaves significant future upside for active ETFs to add more growth.