Actively managed index-based ETFs have increased in popularity1 in recent years, offering differentiated strategies and actively managed risk amid turbulent markets. Dubbed “the next frontier in investor innovation,” active ETFs have seen increased use in model portfolios likely due to their transparency, flexibility, and tax efficiency.2 BlackRock projects active ETFs will reach $4 trillion in AUM by 2030.
Since the beginning of 2019, the number of active ETFs has increased fivefold and AUM in such funds has grown by a factor of seven over the past five years, according to Morningstar3. BlackRock states in the first half of 2024 alone, active ETFs accounted for 41% of all ETF launches – a figure that sat around 25% for all global ETF launches throughout all of 2021. Additionally, the firm claims that U.S., active ETFs accounted for 70% of all U.S.-listed ETF launches from January through June of this year.
The retail channel has been a principal driver of growth in the use of active ETFs, likely thanks to their tax efficiency, access to new strategies, and the prospect of diversified returns. According to a 2022 report by Cerulli & Associates, retail clients’ share of total ETF assets rose from 61% to 80% between 2012 and 2022. Retail financial advisor intermediary channels owned the majority by the end of 2022, with $4.3 trillion, or 66%, of total ETF assets in the market. Within this group, wirehouses and independent RIAs held the most ETF assets, with $1.2 trillion and $1.1 trillion respectively by year’s end 2022.
“First half flows to active ETFs in 2024 nearly eclipsed all of those for 2023 and our own active ETF suite has grown to nearly $50B in AUM after starting the year around $19B,” says Scott Davis, Capital Group Head of ETFs. “This momentum is particularly pronounced in active fixed income ETFs, where assets are up over 60%. The value of active ETFs has clearly been recognized by the market.”
Evolving distribution dynamics are influencing the adoption of active ETFs in the U.S, as many advisors recognize the advantages of transitioning from a commission-based brokerage model to a fee-for-service advisory model. According to insights from BlackRock, this shift enables better alignment with client needs by offering expanded financial planning services and fostering deeper client relationships. Notably, RIAs have been at the forefront of this trend, accounting for approximately 41% of all active ETF assets in the U.S. this year, up from 31% in 2019.
Flexibility and Tax Efficiency Driving Demand
The proliferation of model portfolios has helped spur the increasing use of ETFs by wealth managers. Cerulli anticipates that the percentage of advisors relying primarily on model portfolios is expected to rise, and active ETFs are playing an expanding role in models. A recent analysis by BlackRock4 revealed that, within model portfolios that already included at least one active ETF, the average allocation to active ETFs grew from 12% in 2021 to 19.3% by the first quarter of 2024. This study specifically focused on portfolios containing active ETFs rather than providing an industry-wide assessment of active ETF adoption.
Historically, ETFs were primarily based on market indexes, but the rise of active ETFs is attracting wealth managers who prefer active management and the ability to help optimize the tax treatment of large portfolios.
Unlike mutual funds, which can distribute frequent capital gains, active ETFs have historically distributed fewer capital gains, which has allowed for more efficient and frequent tax-loss harvesting. Active ETFs can complement index-based holdings within a broader portfolio and aim to deliver incremental returns or other client-specific outcomes. Models can be made more efficient by the flexibility and tax efficiency of active ETFs, helping to improve client outcomes.
The integration of active ETFs may also be driven by the desire to deliver client-driven investment outcomes – e.g., tax optimization or growth – helping enable advisors to respond to market changes and adjust portfolios accordingly. “We see certain model providers relying less heavily on the traditional target allocation models and instead developing outcome-oriented models focused on, for example, income production, tax optimization, or downside risk protection,” says Ryan Sullivan of FTSE Russell.
Some model providers are going a step further and providing tax-sensitive models that swap out taxable fixed-income exposure for tax-free exposure, which can be a useful strategy for clients that may be investing outside of tax-sheltered accounts. “For some portfolios we reduced the tax cost ratio, a measure of tax expense, by more than half by incorporating our active ETFs,” notes Kelly Campbell, multi-asset solutions lead at Capital Group.
Objectives-based Models Fuel Active ETF Popularity
“There’s great demand out there for outcome-oriented solutions, and we’re seeing active ETFs increasingly incorporated into these models,” says Sullivan of FTSE Russell, “and in some cases they’re even cannibalizing active mutual fund exposure,” Sullivan says.
The combination of active strategies and liquid, intra-day-priced products like ETFs has given asset managers and advisors more flexibility. While conventional ETFs are undoubtedly a building block of models as well, “clients now want to see active ETFs in their portfolio,” adds Sullivan, as such active funds can allow for further customization and diversification.
Asset managers are responding in kind. Capital Group, an investment management firm with over $2.6 trillion in assets under management as of March 20245, introduced seven new actively managed ETFs in June of 2024. Four equity and three fixed income ETFs now round out the investments group’s 21 ETF options, which offer investors everything from developing-country geographic concentration to ultra-short-term bond durations. Samir Mathur, partner and portfolio manager with Capital Group says, “A lot of our portfolios are objective-based, and active ETFs are a tool that allow us to achieve the right strategic allocation. They have become quite popular, and we find them well-suited to achieving investors’ tax objectives. We have expanded the product suite to offer clients several solutions based on what they’re looking to accomplish.”
In Conclusion
Active ETFs are playing a crucial role in the customization of model portfolios, and the ability to actively manage investments within the ETF framework can provide a balance between passive and active investment strategies.
The Cerulli report claims that by 2026, advisors expect ETFs will make up 25.5% of portfolios, while mutual funds will account for 23.5%, the first time for this to happen since the advent of both investment products. BlackRock anticipates that global active ETF assets under management will surge to $4 trillion by 2030, representing a more than four-fold increase in about six years.
Active ETFs are well-positioned for further growth as issuers continue to provide transparency and flexibility to investors looking for active solutions for both steady and dynamic market conditions.
1 Morningstar, Inc. (November 19,2024). Morningstar’s guide to active ETFs. Morningstar. Retrieved February 3, 2025, from https://www.morningstar.com/funds/morningstars-guide-active-etfs
2 https://www.ishares.com/us/literature/press-release/bai-tek-press-release.pdf
3 Morningstar, Inc. (November 13,2024). 3 great active ETFs for stock investors. Morningstar. Retrieved February 3, 2025, from https://www.morningstar.com/funds/3-great-active-etfs-stock-investors-3
4 BlackRock, Inc. (2023, December). Decoding active ETFs [PDF file]. BlackRock. Retrieved February 3, 2025, from https://www.blackrock.com/ca/institutional/en/literature/market-commentary/decoding-active-etfs-ca-en.pdf
5 Capital Group. (2024, February 1). Capital Group and KKR form exclusive strategic partnership to create public-private investment solutions. Retrieved from https://www.capitalgroup.com/about-us/news-room/Capital_Group_and_KKR_Form_Exclusive_Strategic_Partnership_to_Create_Public-Private_Investment_Solutions.html
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