Will Active ETFs Outnumber Passive ETFs?

Exchange-traded funds have been synonymous with index funds, but that picture is increasingly out of date.

The number of actively managed exchange-traded funds opened to investors has been soaring. If the trend continues, the number of active ETFs in the US could catch up with index-tracking funds within the next few years.

Today, there are 2,149 index-tracking ETFs and 1,619 active ETFs. However, that gap has been narrowing rapidly. So far this year, 331 active ETFs have been listed on US exchanges, following the record 418 active ETF launches in 2023. Just this month, Oakmark, a bastion of active stock-picking, filed to list its first active ETF with a team that includes veteran value manager Bill Nygren.

To be sure, the assets in active ETFs are still dwarfed by index ETFs. Out of the $9.5 trillion of investor money in ETFs, less than 8% is in active strategies. But the momentum is on the side of active ETFs when it comes to the number of investment offerings.

“This is investor driven,” says Paul Olmsted, senior manager research analyst for fixed-income strategies at Morningstar. “I cover a lot of active strategies, and when I ask, ‘Why are you adding an ETF?’ The answer is pretty much the same. That is, investors want the option of an ETF versus a mutual fund.”

However, this boom has not meant a renaissance for traditional stock-pickers. Many of the new active ETFs are so-called systematic strategies, which land somewhere in the middle between active and passive, or they use derivatives as key elements in the portfolio, most notably options-income funds and buffer funds. Active bond ETFs, meanwhile, are also growing rapidly in number.

That’s reflected in the two companies that are leaders in the active ETF space: roughly a fourth of all active ETF assets are managed by Dimensional Fund Advisors and Avantis Investments.

There are “vast flows going into Dimensional and Avantis’ kind of products, and then you have the J.P. Morgan hedged-equity products that have taken in a lot of flows, and that’s a substantial portion of the assets under management in the active ETF space,” says Morningstar’s Stephen Welch, a senior manager research analyst for equity strategies.

The growth in active ETFs stands in stark contrast with open-end funds, where active funds have seen an enormous exodus of investors, especially when it comes to actively managed stock funds.

“You’ve seen the move from mutual funds to ETFs in flows,” says Welch. “More people are rolling [active ETFs] out, trying to take in flows that way when they’re losing assets on their traditional mutual fund business.”

The Active ETF Boom

While the rush is on for active ETFs, the concept isn’t new. The first ones launched well over a decade ago.

However, active ETFs got off to a slow start thanks in large part to Securities and Exchange Commission red tape that required fund companies to seek specific regulatory approval for each active ETF they sought to launch—a time-consuming process.

From 2015 through the end of 2019, 307 active ETFs were listed on exchanges. (The number of listings can include funds that have since been closed.) But the landscape changed dramatically in late 2019 after the SEC adopted a new regulation, rule 6c-11, commonly known as the “ETF rule,” which made launching actively managed ETFs far easier.

That decision opened the floodgates for active ETFs. Of the 1,619 actively managed ETFs currently listed on US markets, 82% were listed since 2020. By comparison, 29% of index-tracking ETFs were listed during that period.

Investor dollars have followed the rush of active ETFs—and out of traditional active mutual funds. From the beginning of 2019 through July 2024, investors moved $541 billion into active ETFs while almost $2.1 trillion flowed out of active open-end funds.

In the first seven months of 2024, active ETFs took in $152 billion, while $366 billion headed into index-tracking ETFs. Meanwhile, active mutual funds have seen investors withdraw a net $229 billion.

Out of the money heading into active ETFs this year, $53 billion went to bond ETFs, and $66 billion was invested in US and international-stock ETFs, which include Avantis and DFA ETFs. Nontraditional equity and alternatives funds, heavily dominated by different types of options-based funds, took in $26 billion.

When measured against the base of existing assets—known as organic growth rates—the gains in active ETFs look even stronger.

“It’s been more than 20% organic growth in assets, every year, like clockwork,” says Bryan Armour, director of passive strategies research for North America at Morningstar.

Why Active ETFs Are Gaining in Popularity

The popularity of ETFs broadly stems from several advantages they have over traditional open-end mutual funds. They are more tax-efficient, can be traded like stocks, and report holdings every day. They are also, on average, significantly cheaper than mutual funds. This is especially the case among active funds, where the average active ETF has a 36% lower expense ratio than the average active mutual fund.

While active management’s market share has been slipping overall, the rise in popularity of ETFs has been large enough that active ETFs have grown, even as actively managed funds’ market share has shrunk.

While it’s impossible to tell exactly where the money from active mutual funds is going and where the flows from ETFs are coming from, it is likely that a significant portion of investor dollars flowing into active ETFs are coming out of actively managed mutual funds. “I would definitely say that’s the case,” says Armour.

Armour says it’s possible that the number of active ETFs could eclipse the number of index ETFs, but a bigger turning point would be if the SEC approves wider adoption of Vanguard’s model allowing an ETF share class of mutual funds. This would allow companies to more easily create ETFs based on existing active mutual funds. Some two dozen fund companies have petitioned the SEC for the ability to follow this approach.

The New Faces of Active ETFs

One potentially differentiating factor behind the growth of active ETFs at a time when active mutual funds are bleeding money is the type of ETF that investors are gravitating toward. “It’s not mostly traditional stock-pickers getting assets under management,” says Welch. Instead, systematic active stock ETFs and derivatives-based ETFs are gaining traction.

Roughly a fourth of all active ETF assets are managed by Dimensional Fund Advisors and Avantis Investments, which is part of American Century Investments. These firms’ active ETFs don’t rely on traditional stock-picking. Instead, Dimensional and Avantis employ quantitative rules to determine their funds’ holdings.

“They are kind of more like strategic-beta products,” says Welch.

Another major area for active ETFs is derivatives-based funds. These come in two main forms, options-income funds and buffer funds.

Best known within the options-income category are the $35 billion JPMorgan Equity Premium Income ETF JEPI and the $16 billion JPMorgan Nasdaq Equity Premium Income ETF JEPQ. These funds generate income by selling options based on a portfolio of stocks, often, such as in the case of the JPMorgan funds, based on a major stock index. Derivative-income funds like these make up more than 8% of all active ETF assets.

Options-trading funds are another group, which makes up 6% of active ETF assets. These ETFs use derivatives to protect investors from losses but also give up a portion of potential gains.

Another 32% of assets in active ETFs are in bond funds, where active managers have a significantly better track record of beating comparable index funds than do active stock funds.