What lies ahead for active ETFs?

Report highlights tailwinds from growing advisor awareness and cost benefits, as well as regulatory areas to watch.

Despite its limited profile in the investment fund landscape, the active ETF industry has seen remarkable growth in recent years – and the near term could prove to be a pivotal chapter in this Cinderella story.

According to a new report from ISS Market Intelligence, active exchange-traded funds have witnessed a surge in interest, reaching $422 billion in assets by mid-year 2023. This represents a significant jump, with these ETFs attracting $47 billion in net new flows in the first half of 2023 alone.

“The growth of active ETFs is particularly noteworthy, considering their starting point,” ISS Market Intelligence noted. “It’s a testament to the evolving investor demand and the industry’s adaptation to market needs.”

This expansion comes as asset managers are streamlining their offerings, leading to a record number of fund liquidations in 2020. But compared to passive ETFs and mutual funds, active ETFs have seen comparatively fewer liquidations, underscoring their resilience and growing appeal among investors.

The transition toward ETFs over the past decade has been stark, with ETFs now holding a 30% market share compared to mutual funds. That shift has been driven by a mix of advisor and investor awareness of ETFs’ advantages, including tax efficiency, lower fees, and active management capabilities.

A significant number of financial advisors are increasingly integrating active ETFs into their portfolios, the report said, noting “Low fees and tax efficiency are the primary catalysts … with 63% of advisors citing cost as a key factor in their preference for active ETFs.”

The report said more than three-quarters (77 percent) of advisors consider track record and performance among the top three quarters in selecting a new asset manager for active equity ETFs.

Younger advisors are leading the charge in adopting active ETFs, with those ages 30 to 39 planning to increase their usage significantly. This demographic shift indicates a broader change in investment strategies and preferences, potentially shaping the future landscape of fund management.

Regulatory decisions remain a critical factor in the trajectory of active ETF growth. The report pointed to several possible accelerating developments, including the possibility that the SEC could let other managers use the Vanguard ETF share class structure for active ETFs, along with a relaxation of regulations around allowable equity strategies.

While there’s still room to run in the active ETF space, asset managers looking to enter that blue ocean shouldn’t expect smooth sailing.

“There’s a high fail rate for active ETFs, with about 70% of those launched in 2019 not reaching the $1 million mark in annual revenues by 2022,” the report highlights. “Of course, that is a high hurdle in this environment, where attracting assets in any new product (regardless of vehicle) is extremely difficult.”