The rise of active ETFs – what are they and why are they becoming more popular?

Active exchange traded funds (ETFs) have been around for a long time, but have risen in popularity in recent years.

Investors might be more familiar with passive ETFs that track the performance of an index like the FTSE 100.

In contrast, the aim of an active ETF is to outperform a certain benchmark. This is the same for active funds, including some of the funds on our Wealth Shortlist.

What’s the difference between ETFs and funds?

ETFs and funds are similar in some ways, and can both use active or passive styles. However, their legal structure is quite different, and they trade in different ways.

Unlike mutual funds, ETFs trade on stock exchanges, like shares, which means you pay a dealing charge. This also means their price changes throughout the day. A mutual fund, on the other hand, only prices once a day.

This article isn’t advice. All investments can rise and fall in value, so you could get back less than you invest. If you’re not sure if an investment’s right for you, ask for financial advice.

Why are active ETFs becoming popular?

Active ETFs are gaining interest as they have the potential to outperform the market, while maintaining all the benefits that come with investing in ETFs.

Active management involves a fund management team researching opportunities and creating a portfolio of investments they think will perform better than the ETF’s chosen benchmark. Although of course this isn’t guaranteed.

Whereas a passive ETF is simply looking to match the performance of its benchmark. So, if the index falls in value, the ETF will fall by a similar amount.

Being able to invest actively within the ETF structure has made them popular with investors.

How quickly are active ETFs growing?

Active ETFs have grown tremendously recently, passing $900bn in assets this year and are well on their way to reach the $1tn mark.

To put that into context, the global ETF industry has around $14tn of assets under management. So, active ETFs still only make up a small slice of the total ETF pie.

But they are growing rapidly – BlackRock expects they’ll quadruple to $4tn by 2030.

In the first half of 2024, net new money invested in active ETFs represented 25% of the total amount invested in ETFs globally.

And over the past 12 months to the end of June, over 60% of all new ETFs launched globally have been active.

Who are the biggest players in the active ETF market?

Despite this being a global trend, the US currently dominates the active ETF market.

There are a few reasons for this, but the main one is that there are certain tax benefits for holding ETFs over mutual funds in the US, which make active ETFs attractive for US investors.

This doesn’t apply to the UK though.

The regulation of ETFs also differs in the US.

Previously, managers of ETFs were required to publish a full list of the fund’s holdings every day. For lots of active managers, this full transparency is off-putting because it enables others to copy their portfolios.

But in 2019, this changed in the US when the Securities Exchange Commission brought in a new rule allowing ETFs to become ‘semi-transparent’. This rule also provides other benefits like enabling ETFs to come to market more quickly.

This has helped fuel the growth of active ETFs in the US, with over 1,100 new active ETFs launched in the US since this change.

Europe is lagging, but not for much longer

Demand for active ETFs has been slower in Europe. They currently only make up around 2% of the total European ETF market.

The rules in Europe still require ETFs to publish their full portfolio holdings daily.

However, the Central Bank of Ireland, which regulates most of Europe’s ETFs, is said to be reviewing these rules later this year.

A change in ETF rules, in line with the US, could boost the growth of active ETFs on our side of the pond.

Despite this, demand in Europe is still growing.

In the first half of 2024, net new money invested in active UCITS ETFs was $5.7bn versus $3.9bn in the first six months of 2023.

Several large asset managers, like J.P. Morgan and BlackRock, have already launched active ETFs in Europe. And they’re becoming an area of focus for many others.

The next few years are likely to be exciting ones for the ETF market in Europe.