Actively Managed ETFs: The $1 Trillion Milestone

Actively managed ETFs are on the cusp of a monumental achievement: reaching $1 trillion in assets under management. This milestone is not just a number; it signifies a shift in investor preferences and the growing acceptance of active management within the ETF landscape. The reasons behind this surge are multifaceted, driven by a combination of investor demand, regulatory changes, and the unique benefits that actively managed ETFs offer.

Investor Demand for Active Management

One of the primary drivers behind the growth of actively managed ETFs is the increasing demand from investors for active management strategies. In an uncertain market environment characterized by high inflation, rising interest rates, and slowing global growth, investors are seeking strategies that can provide consistent income, generate additional yield, and protect against market volatility. Actively managed ETFs offer these benefits by allowing portfolio managers to make strategic decisions and adjust asset allocations in real-time based on market conditions.

Regulatory Changes and Innovation

The regulatory landscape has also played a significant role in the growth of actively managed ETFs. In 2019, the Securities and Exchange Commission (SEC) introduced changes that opened the door for innovation in the active ETF space. These changes provided a consistent framework for issuers to launch and manage active ETFs, leading to a flood of new entrants and a wider range of strategies. This regulatory environment has fostered innovation and allowed active ETFs to compete more effectively with their passive counterparts.

Tax Efficiency and Tactical Opportunities

Actively managed ETFs offer several unique benefits that set them apart from traditional mutual funds and passively managed ETFs. One of the key advantages is tax efficiency. ETFs are designed to generate fewer capital gains distributions, reducing the number of taxable events passed on to investors. This is particularly beneficial for actively managed ETFs, which may change their portfolio composition more frequently than passively managed ETFs. The ability to change the portfolio composition without realizing taxes is a significant advantage, as it allows investors to benefit from the active management strategies without incurring additional tax liabilities.

Another unique benefit of actively managed ETFs is the tactical opportunities they provide. Unlike passively managed ETFs, which are designed to replicate the performance of a specific index, actively managed ETFs are controlled by investment managers who target specific investments within themes. For example, in active bond ETFs, investment managers can pick securities based on factors such as interest rate changes, global credit risks, duration, or credit quality. They can also determine the size of their positions in these securities using fundamental or quantitative techniques. This allows them to outperform passive index funds by finding opportunities amid the complexities and inefficiencies of the bond market, offering investors the potential for income, diversification, and liquidity.

Performance Metrics and Expense Ratios

While actively managed ETFs generally have higher expense ratios compared to passively managed ETFs, they aim to deliver returns exceeding their reference benchmark, known as "alpha." For example, the Avantis U.S. Equity ETF (AVUS) has an average annual return since inception of 14.70%, outperforming the S&P 500 Index over the past three years. Similarly, the Dimensional US High Profitability ETF (DUHP) has an average annual return since inception of 12.6%, with earnings per share growth and sales growth both topping its peer group’s averages. These performance metrics suggest that actively managed ETFs can provide superior returns, but there is no guarantee for alpha.

Investors seeking to maximize returns must weigh the potential for higher returns against the higher expense ratios of actively managed ETFs. While passively managed ETFs offer pure exposure to a designated slice of the market, known as "beta," actively managed ETFs try to deliver returns exceeding their reference benchmark. Therefore, investors looking to complement existing holdings may opt for an actively managed fund that has the potential to beat the market, despite the higher costs.

The Future of Actively Managed ETFs

The growth of actively managed ETFs is expected to continue, with BlackRock forecasting that assets in actively managed ETFs will quadruple from $900 billion to $4 trillion by 2030. This projection points to the rising investor demand for active management strategies that can provide targeted exposure and tax-efficient benefits in an uncertain market environment.

In conclusion, the $1 trillion milestone for actively managed ETFs is a testament to their growing popularity and the unique benefits they offer. As investors continue to seek active management strategies, the future of actively managed ETFs looks bright, with the potential to become a dominant force in the ETF landscape.