Actively managed ETFs have hit their stride and this trend is set to continue. Once a largely passive vehicle, ETFs are now a core part of many asset managers’ active strategies. Increasingly, flagship active strategies are launching in, or being converted to, the ETF wrapper.

“We believe active ETFs have gathered critical mass given their advantages — typically lower expenses, intraday liquidity and continuous pricing, greater tax efficiency and transparency,” said Bram Kaplan, Head of Americas Equity Derivatives Strategy at J.P. Morgan. “And they have a long runway ahead — active ETFs only account for around 7% of total U.S. ETF assets,” Kaplan added. “Put another way, they only hold around 4% of the assets in actively managed funds, while mutual funds retain a 96% share. We expect active ETFs to increasingly take market share within this universe.”

However, the broader rotation from active to passive funds — which has seen over $4 trillion of flow in that direction over the past decade — is unlikely to reverse. This means growth in active ETFs will likely come at the expense of active mutual funds, rather than passive ETFs. 

ETF fees have been persistently squeezed in recent years. Average fees paid across ETFs have decreased nearly 50% in the U.S. since 2012, reaching an AUM-weighted average of around 18 basis points. This trend has been driven by investors gravitating toward lower fee funds, and ETF issuers cutting expense ratios to remain competitive. The fact that investors are attracted toward lower fee funds is nothing new. In nine out of the last 10 years, more than 75% of total ETF inflows went into the lowest quintile of funds according to expense ratio.

“However, average ETF fees were little changed over the last year given increased flows into actively managed and option-based funds,” Kaplan said. “In the actively managed segment, fee pressures are somewhat lighter and the AUM-weighted average expense ratio for U.S.-listed funds is nearly triple that for passive funds.”

Does this mean an end to decreasing ETF fees? “Actively managed ETFs are certainly on the rise, and they are more expensive,” Kaplan noted. “However, investors are still price conscious. Even during the last year, the most expensive funds have continued to see limited investor interest.” 

Investor adoption of option-based ETFs is broadening, driving strong growth in assets and in the number and variety of products. There are two main strategies in this segment: call writing funds that sell call options to generate income, and buffer ETFs that overlay an option-based hedging strategy to an equity portfolio in order to limit or cap the losses it can face. The first ETFs that trade zero-day to expiry options launched last year, capitalizing on the popularity and liquidity of ultra short-dated options. Additionally, some option-based ETFs that replicate structured retail products have recently come to market. Volumes are mainly concentrated in the U.S., where AUM in option-based ETFs have grown to around $115 billion — an increase of more than 600% over the past three years — across more than 350 funds.

With their rising popularity, option-based ETFs have become a large source of volatility supply. “Option-based ETFs are weighing on equity market volatility,” Kaplan noted. “In our view, this is one of the major reasons for the decline in equity market volatility seen throughout the past year.” Some have drawn comparisons to the buildup of assets in short CBOE Volatility Index (VIX) exchange traded products (ETPs) ahead of 2018’s “Volmageddon” episode. At that time, volatility had remained low for around a year before the VIX spiked from 18 to 37 over the course of one day, causing large losses for inverse strategies. But for J.P. Morgan Research, conditions look to be different this time. “We don’t see a similar mechanism at play in option-based ETFs that could produce a Volmageddon-type episode,” Kaplan said.

One outlier within a year of low volatility came on August 5, 2024, when the VIX experienced its largest ever intraday spike. Option-based ETFs weren’t the cause, and they didn’t experience the large losses seen during Volmageddon — at the same time, they provided little resistance to the surge. This is because they only suppress volatility over a relatively narrow price range and in the event of a 5-10% sell-off, markets can be left more vulnerable. “On August 5, we moved outside the range where option-based ETFs materially suppress volatility,” Kaplan explained. “Then, as the market recovered and overwriting positions were rolled down and out, option-based ETFs and dealer option hedging began suppressing volatility once again, contributing to the VIX’s rapid retracement.” 

Thematic ETFs provide exposure to macro trends that can’t be traded via traditional regional, sector or factor exposures. They took off in the early days of the COVID-19 pandemic when investors showed strong interest in themes relating to innovation and digitalization. However, many of these strongly underperformed in late 2021 to 2022, and the thematic ETF space is yet to recover.

Demand for thematic ETFs remains relatively weak, with those listed in the U.S. recording net inflows of around just $4 billion over the past year, and outflows year to date. Yet despite this weakened demand, issuers continue to focus on the segment. Around 50 new thematic ETFs have launched in U.S. during the last year, which accounts for around 9% of all new ETF launches over this period.

When generative AI and large language models caught investors’ attention, it seemed this could be a new driver for interest in thematic ETFs. But flows into AI-related themes remain muted compared to those seen during the innovation-led thematic boom a few years earlier, with around $3 billion of new assets over the past year. Instead, investors appear to have focused on passive products in the segment. “We estimate around $40 billion flowed into passive U.S. ETFs focused on tech, semiconductors and the Nasdaq over the past year,” Kaplan said. “Additionally, leveraged exchange traded products (ETPs) in the space have grown significantly over the past year thanks to their strong performance, even as investors overall withdrew money from these funds.”

Interest in ESG ETFs has slowed significantly over the past few years after experiencing exponential growth between 2016 and 2021. In the U.S., ESG funds have attracted close to zero net flows over the past two years, and few new ESG funds are being launched. “In our view, there are three main reasons for this,” Kaplan said. “It’s a combination of underperformance (particularly in 2022 when energy was the best performing sector), controversy around definitions and increasing politicization of ESG.”

While European ESG funds have seen significant inflows overall during the past year, interest there has also diminished. Despite this, Europe continues to dominate the ESG ETF marketplace. ESG ETFs remain a focus area for issuers in Europe, with around 90 new ESG-screened products launched over the past year — in the U.S., this number was only around 20. Europe remains well ahead of the U.S. in terms of products offered, AUM and regulations, and the gap between the regions is widening further.

The U.S. Securities and Exchange Commission (SEC) approved the first single-stock ETF listing in July 2022 — there are now around 60 available, with approximately $8.7 billion in total assets. Single-stock leveraged ETFs provide an access vehicle for investors to go short, gain leveraged long exposure or receive risk-tailored exposure (via option strategies) to a number of single stocks.

Most of the AUM in single-stock ETFs is focused on tech names. A year ago, around two-thirds of the assets in single-stock ETFs were in funds that track Tesla stock (TSLA) and one-sixth were in funds that track NVIDIA (NVDA). Since then, assets have broadened and investors’ interest has turned to AI where NVDA is outperforming. Now, nearly half of single stock ETF assets are in NVDA funds and around 20% are in TSLA.

Over the past year, ETF issuers significantly expanded their offerings of multi-asset ETFs. 40 of around 150 outstanding multi-asset ETFs are new since last year, as issuers try to get a foothold in this segment. However, the multi-asset space has been challenging, as around one-quarter of the funds that were active a year ago have since been liquidated and AUM growth has been slow.

In J.P. Morgan Research’s view, multi-asset funds have likely struggled to gather assets because:

1. Advisors generally provide their own asset allocation models and are unlikely to steer investors to an all-in-one asset allocation fund.
2. Fees are relatively high in this space.
3. Some of the strategies can be complex and/or opaque.