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Advisors Embrace Active ETFs: A Win for Investors and Fund Providers

Retail investors have plenty of pull when it comes to fund preference and choice. However, it’s professional investors and the advising community that really drive the bus. These days, the preference remains exchange traded funds (ETFs). The benefits of using the ETF structure continue to impress and drive asset allocation decisions.

And it looks like active ETFs are quickly becoming the vehicle of choice for professionals.

That’s the gist anyway, according to a new survey by ISS Market Intelligence. From registered investment advisors (RIAs) to broker-dealers, the use of active ETFs for portfolio construction continues to grow. Looking ahead, the use of active ETFs by professionals is set to skyrocket. That’s great news for both fund providers and those looking for more choices in their portfolios.

A Big Surge

The number of active ETFs has continued to surge in recent years. Driven by a variety of factors — such as rules changes at the SEC as well as mutual fund-to-ETF conversions — there are now over 1,500 active ETFs that hold nearly $700 billion in assets. This number is roughly double what active ETFs held at the end of 2022.

The huge number of funds on the market is all well and good … if people use them to build their portfolios — and it looks like they are.

In a recent report from ISS Market Intelligence, advisors are bullish on active ETFs for their portfolios and clients’ needs. This includes advisors of various types: Surveying hundreds of RIAs, broker-dealers, wirehouses and hybrid RIAs, ISS found that most advisors are planning to increase their use of active ETFs going forward.

According to the report, which looked at eight independent surveys, more than 48% of advisors at hybrid RIAs plan to increase their use of active ETFs. Similarly, 45% of RIA-only advisors expect to do the same. That’s the highest percentage of any category, including mutual funds — passive and active. Other vehicles, such as separately managed accounts (SMAs) and liquid alternatives, failed to generate any significant buzz among advisors. 1

This shift towards active ETFs and their role in portfolios is significant because RIAs managed about $7.8 trillion in household wealth. 2

Low Fees & Taxes

The reasons behind advisors turning to active ETFs are the benefits of the exchange-traded-fund structure. According to ISS, “low fees and tax efficiency are the primary catalysts,” with 63% of advisors citing costs as a primary factor in making the shift to ETFs over other fund vehicles.

It’s true. ETFs — whether passive or active — are generally much cheaper for fund sponsors to operate than other structures. This is key for active management. A lower fee means a lower hurdle that managers need to clear in order to provide a benefit to their investors. With some active ETFs now costing as little as 0.15%, any extra return is able to be given back to investors.

The same could be said for taxes. The creation-redemption structure of ETFs allows authorized participants to receive in-kind assets, which push capital gains taxes out of the ETF and helps reduce tax-drag on returns.

Aside from wanting to do right by their clients, there may be another reason why advisors like active ETFs: They must do right by their clients.

Fiduciary responsibility is quickly becoming a legal obligation for advisors. While the Department of Labor (DOL) and Consumer Financial Protection Bureau rules have been challenged, tweaked and lambasted by some in the advisor community, the final Fiduciary Rule is in its last stage. Even without the legal rule, the cat is out of the proverbial bag. Clients have continued to flock toward RIAs that work in their best interest. Meanwhile, lawsuits targeting 401(k) and IRA providers that breach their fiduciary responsibility have grown in number during recent years.

Active ETFs, with their low costs and tax efficiency, fit under the guise of fiduciary responsibility. Choosing them for portfolio management provides advisors with the ability to craft potentially market-beating portfolios without having potential crosshairs on their backs — this alone could help grow the fund type going forward.

A Word Of Caution From ISS

Nonetheless, the growth of active ETFs — and the adoption of them by advisors — isn’t without some critique and words of caution for fund sponsors. According to Christopher Davis, head of U.S. Fund Research for ISS Market Intelligence, “Product excellence is a necessary but insufficient ingredient for success in the active ETF arena.” Without the right marketing and distribution strategy, a great fund isn’t going to drive traction.

Secondly, packaging a “bad” fund or strategy into an ETF isn’t going to be a panacea either: A bad active manager is a bad active manager. An ETF won’t help that fact. This is important considering the survey showed 77% of advisors look at track record history when selecting a new active ETF — or active ETF-selling firm — for their clients.

Popular Active ETFs 

These ETFs are sorted by their YTD total returns, which range from -2.3% to 15%. They have expense ratios between 0.17% and 0.36% and assets under management between $9.4B and $33B. They are currently yielding between 0.8% and 9.7%.

In the end, ISS Market Intelligence’s new survey shows that advisors are warming up to active ETFs for their clients’ needs and to meet their goals. For the industry, it’s a great thing. It’s a great thing for investors as well. Ultimately, active ETFs provide plenty of benefits for a portfolio. With their growth, investors now have more choices for their portfolios.

Bottom Line

The number of active ETFs has surged in recent years — and it looks like the growth will continue. According to the recent ISS Market Intelligence survey, advisors are starting to use them in a big way. With more advisors selecting active ETFs for their clients, it should create a flywheel effect, thereby providing plenty of opportunities for investors.

1 ISS Market (Dec 2023). Evolving Portfolio Construction and Active ETF Decision Framework

2 CityWire (Feb 2024). RIAs plan to use active ETFs more often: Study