It’s easy to think of exchange-traded funds (ETFs) as passive investment vehicles – baskets you can buy, hold, and forget. But as we’ll show, ETFs can be more active today than many people imagine.
A Big Change in Indexing and ETFs (But They’re Not the Same Thing)
It has now been over 30 years since the first US ETF (SPY in 1993) was launched. During that time, index funds (including ETFs) have grown strongly. Most databases now show that the assets of index funds have exceeded the assets of active mutual funds.
Chart 1: Passive Near Active Fund Assets
Interestingly, at the same time, data shows that ETFs have steadily increased assets, while mutual funds have seen steady outflows.
Chart 2: ETFs are gaining assets while mutual funds are losing assets
The important thing is that these two charts do not show the same thing. Notably:
- Mutual funds also include index assets.
- ETFs also include active exposures (which we’ll focus on below).
What the second chart highlights is more likely a demographic shift. As mobile apps democratize investing, ETFs are an easy and efficient way to access the market. Replacing the old process of sending checks to investment companies to invest in their funds.
To address this change in consumer behavior, the US Securities and Exchange Commission (SEC) is now considering several requests to allow mutual funds to list their units as a new share class to be allowed to trade on the exchange.
ETFs provide investors with options to build an active portfolio
There are now more than 4,400 ETFs listed in the US, but they are not all the same.
There are ETFs that offer custom thematic exposure as well as asset class, country, size, style, and sector exposure. Some ETFs also have option overlays. This gives investors a lot of options for building ETF portfolios that can be very different from a “total market index fund.”
Despite the success of ETFs, more stocks are listed in US markets. In fact, when you include rights, warrants, preferred shares, special purpose acquisition companies and other listed products the total NMS securities are approximately 12,000.
Young investors trade more actively
Nasdaq’s ETF retail investor survey found that younger retail investors trade more actively than older investors. A quarter of Gen Z trade multiple times a day (compared to only 2% of Boomers).
In other research, we have shown that retail investors trade heavily using ETFs and buy ETFs almost every day.
Chart 3: Young investors trade more actively
ETFs are also active
An often overlooked fact is that many ETFs are now actively managed portfolios.
In fact, most of the new ETFs last year were active ETFs. Active ETFs account for more than 12% of the more than $13 trillion in U.S. ETFs.
Chart 4: Active ETFs account for more than 12% of all US ETF assets
Active ETFs don’t just track a market cap index. Portfolio managers make investment decisions by selecting stocks and changing weights. Often, the portfolio (or at least the creation basket) is shared publicly to allow arbitrageurs to hedge buying cash flows into the ETF during the day. They are basically mutual funds that trade intraday like stocks.
Investors are very interested in active ETFs
In the same ETF retail investor survey, we also saw that more retail investors are interested in active ETFs than passive ETFs.
Chart 5: Retail investors remain very interested in active ETFs
Again, it is no surprise to see in the data that active ETFs are seeing a larger allocation of new inflows into ETFs. According to Nasdaq’s Index Product Intelligence team, more than a third of new ETF investments are buying active ETFs, despite them accounting for a much smaller portion of the underlying assets.
Chart 6: Active ETFs are growing faster than passive ETFs
ETFs are becoming more active, and that’s good for investors
What we see in today’s data is that the “indexes vs. active” debate is very different from the “mutual funds vs. ETFs” debate. that’s because:
- ETFs are Both A mutual fund and a stock.
- ETFs are becoming more active. This is helping ETFs capture even more market share from investors.
It seems clear that ETFs are more attractive to younger investors, and are easier to access through trading apps, and can be traded more easily and cheaply.
Given this, it’s no surprise that many investment managers are now looking to convert older active mutual funds into ETFs – either by relaunching them directly as ETFs or trying to adopt the new dual share class listing rules currently being considered by the SEC.
