Morningstar - Q3 2024 - 24

Spotlight: State of Active Investing
strategies and asset classes. Can ETFs, originally
designed to give investors better access
to passive strategies, be the vehicle that helps
reverse active investing's decline?
A few catalysts have driven the rapid growth
of active ETFs:
1 The SEC in 2019 passed what is often called the
ETF rule, streamlining the ETF listing process
and giving portfolio managers more flexibility
when creating and redeeming ETF shares.
2 Investors and their advisors have increasingly
sought out low-cost funds.
3 Portfolio managers have accepted greater
portfolio transparency.
4 Traditional mutual fund providers began to convert
existing mutual funds into ETFs.
Active ETFs Are Not a Panacea
As the headwinds grew stronger for active mutual
funds, fund companies began launching ETFs.
But pivoting to ETFs does not assure asset growth.
Some asset managers have found salvation
in the ETF market, and they have quickly risen
through the ranks of the largest active ETF issuers.
Others have failed to translate the success
of their mutual fund franchise to the ETF market.
For active ETFs, it's less John F. Kennedy's
" a rising tide lifts all the boats, " and more Warren
Buffett's " it's only when the tide goes out
that you learn who's been swimming naked. "
ETFs' transparency exposes them for what they
are, benefiting some and hurting others.
This leaves a small number of asset managers
for which active ETFs are a good fit. Most of
the 320 providers that have launched active ETFs
have had limited success. Only a handful of
issuers have been successful so far ( EXHIBIT 2 ).
The same factors that decide fates across
the investment industry determine
active ETFs' winners and losers. These include
performance, breadth of offerings, and,
most importantly, fees.
Investors' preference for lower-priced investments
continues with active ETFs. Funds in the
cheapest quintile of active ETFs hold more than
$325 billion in assets, while those in the
most expensive quintile hold just $35 billion.
Today's leader, Dimensional, charges an
average fee of just 0.24%, a fraction of the whole
group's 0.69%. It still pays to be cheap.
Asset managers aren't the only ones that should
pay attention to the evolution of actively
managed ETFs. Investors should understand the
nuances that ETFs introduce to actively managed
portfolios. ETFs offer several advantages
over mutual funds, such as better tax efficiency,
transparency, and lower fees, but they also
have a few disadvantages.
Key considerations for investors include:
EXHIBIT 1
Active ETFs' Growth Accelerates Assets under management and the number of
active ETFs have risen sharply over the past decade.
1,500
1,200
900
600
300
$1,000B
Number of
Active ETFs
1,326
800
Active ETF AUM
611.31
600
400
200
2008
2010
2012
Source: Morningstar Direct. Data as of March 31, 2024.
2014
2016
2018
2020
2022 2024
gETFs lack capacity constraints, meaning they
can't close to new investors when their
fund gets too big for their investment strategy.
Investors need to watch the size of concentrated
active ETFs that play in small sandboxes.
Given their lack of capacity constraints, active
ETFs in large-cap categories are best suited
for the ETF wrapper, although those markets are
also the toughest for active managers to
outperform passive peers.
gThe flexibility of ETFs comes at a price. Since
ETFs trade like stocks, they also have bid-ask
spreads, or the difference between what
buyers offer and sellers ask for shares. When
spreads are wide, they add to investors'
costs. Smaller, more unique ETFs can have wide
spreads, especially near the opening
and closing of the trading day when liquidity
tends to be thin.
Investors Favor Few Active ETFs
Given the benefits and drawbacks of ETFs, it
is no surprise to see active ETF assets
concentrate in more-liquid corners of the market
( EXHIBIT 3 ). US large-cap, ultrashort bond,
and core bond Morningstar Categories are among
active ETFs' largest by AUM. Options-related
active ETFs have also seen success by catching
a major trend in covered-call strategies and
buffer funds.
24
Morningstar Q3 2024
$800B
Janus Henderson
Morningstar - Q3 2024

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