Key Takeaways: The Active ETF Boom

• Actively managed ETFs are experiencing explosive growth, accounting for a significant portion of net inflows and new launches in 2024.
• A 2019 SEC rule change paved the way for this shift, making it easier to convert mutual funds into ETFs.
• Successful active ETFs are not simply replicating traditional stock picking; they are offering innovative strategies like options-based income generation and defined outcome products.
• Fixed income and AI-driven thematic strategies present significant growth opportunities for active ETFs.
• The success of active ETFs offers asset managers a potential solution to shrinking margins in the face of passive competition.

The Rise of Active ETFs: More Than Just Stock Picking

The growth of actively managed ETFs isn’t simply a revival of traditional stock picking. Instead, it represents a strategic innovation with a focus on providing investors with alternative, more sophisticated investment strategies. JPMorgan’s Equity Premium Income ETF (JEPI) and Nasdaq Equity Premium Income ETF (JEPQ) exemplify this evolution. While incorporating stock-picking components, these funds significantly rely on options trading for income generation, offering investors a compelling blend of equity exposure and income stream. This innovative approach is proving highly attractive in the current market environment.

Buffer Funds and Defined Outcome Products: Managing Risk and Certainty

Another significant trend is the rapid growth of buffer funds. These funds, offered by various issuers, employ derivatives to limit potential losses, offering investors a higher degree of certainty. This approach to risk management is resonating strongly with investors seeking to mitigate downside risk in unpredictable markets. As **Matt Collins**, head of ETFs at PGIM Investments, notes, “The industry has been looking for ways to challenge passive, to almost no success. And now that you’re giving basically passive with alterations, where you can plug and play based off of your goals, it’s just been a game changer I think for active.”

Factor-Based and Thematic Strategies: Capturing Market Trends

Beyond income-focused strategies, actively managed ETFs are finding success in other niches. The iShares U.S. Equity Factor Rotation Active ETF (DYNF), for instance, has amassed over $11 billion in inflows in 2024. This fund’s success stems from its focus on identifying and capitalizing on quantitative factors, making it a valuable complement to core passive holdings within model portfolios. This shows that active ETFs are not necessarily trying to fully replace passive strategies, but rather enhance and diversify them.

“The most successful active conversions have offered differentiated access to markets or strategies with fewer ETF competitors, including ‘quantamental’ equity, high-yield fixed income, thematic funds, and options strategies,” wrote Jared Woodard, ETF strategist at Bank of America. This highlights the importance of offering unique strategies in a competitive space.

Future Growth Areas: Fixed Income and Beyond

The success of specific active ETF strategies points toward promising growth areas for the industry. The relatively slower adoption of ETFs in the fixed-income market presents a significant opportunity. Jon Maier, chief ETF strategist at JPMorgan Asset Management, highlights this potential, noting that “The overall fixed income market is probably 75% active. But the ETF space is not — it’s largely passive.” The Janus Henderson AAA CLO ETF (JAAA), with its impressive $11 billion in inflows and 7.3% year-to-date return (through Dec. 26), demonstrates the potential for active strategies in this space.

The Allure of AI-Driven Thematic Investing

Another area poised for growth is AI-driven thematic investing. The rapid evolution of artificial intelligence creates challenges for traditional sector classifications, making actively managed funds adept at identifying and tracking emerging trends particularly attractive. The AB Disruptors ETF (FWD), with significant holdings in companies like Nvidia and Vistra Corp., showcases this approach. Its outperformance of the Nasdaq 100 and over $200 million in inflows is a testament to the growing investor interest in this space. Noel Archard, global head of ETFs at AllianceBernstein, emphasizes the appeal of funds that offer diversification beyond single themes. **”I think what folks find attractive about that particular exposure is that it doesn’t just drill down into one particular theme,”** Archard said.

The Impact on Asset Managers: Preserving Revenue and Adapting to Change

The shift toward actively managed ETFs is equally significant for asset managers. In the face of declining fees from passive competitors, the success of active ETFs presents a crucial opportunity to protect and grow revenue. The potential to charge higher fees for more complex, harder-to-replicate strategies is particularly enticing. ETF conversions are also proving to be a critical tool. **”ETF conversions can stem the tide of outflows and attract new capital,”** says **Jared Woodard**. The data supports this, showing that mutual funds converted to ETFs saw an average of $150 million in outflows before conversion followed by $500 million in inflows after. This signals a strong preference among investors for active management within the flexible and transparent framework provided by ETFs.

Johan Grahn, head ETF market strategist at Allianz Investment Management, summarizes the overall situation clearly: “The market itself is very loudly and very clearly favoring the actively managed strategies in ETF wrappers.” Looking ahead, the momentum behind actively managed ETFs appears undeniable, suggesting a significant and sustained shakeup in the investment management and allocation strategies being employed.