MB: Active is a second trend. Active ETFs have had record flows so far in 2024, taking in US$218 billion, and are on pace to surpass US$1 trillion in AUM by next year.5 The rise of active ETFs is built upon two types of actively managed portfolios: traditional alpha targeting strategies and exposures seeking to provide a specific outcome (like income, lesser volatility or enhanced diversification).
While traditional alpha-focused strategies can be viewed under this lens of democratized customization, as when compared to similar active mutual funds they offer the same access to all investors (e.g., no multiple share classes, fee schedules, offering price), the growth of outcome-based active ETFs fully crystalize the trend. However, outcome-based active ETFs would not have been possible if regulatory frameworks on how to bring active ETFs to market (SEC rule 6c-11) and the nature of derivative usage (SEC rule 18f-4) were not altered.
With lesser restrictions on derivative usage, more novel products were brought to market – and in quicker succession as listing standards were no longer as onerous. Over the last 25 years, 355 active ETFs using derivatives were launched.6 This is three times greater than the number of similar funds launched over the prior 25 years. These would be considered alternatives, as they are either modifying a return stream or seeking enhanced diversification through the use of derivatives.
The market for defined outcome ETFs (funds that target a specific upside and downside level over a defined period) is seeing a surge in usage. They are now more commonly being used by investors to manage volatility. This trend is illustrated by the category’s accession over the last four years coinciding with the fall of low volatility factor ETFs’ role as a common solution to mitigate risks. Defined outcome ETFs have taken in US$28 billion over the last four years, while low volatility factors ETFs have lost US$29 billion.7
At State Street Global Advisors, we recently launched derivative income, hedged digital asset and actively managed target maturity ETFs. These alternative and active ETFs are designed to help investors meet specific portfolio goals of income and diversification. They complement some of our existing active and alternative strategies focused on gold, multi-assets and commodities.
Beyond State Street Global Advisors’ launches, the use of non-traditional or alternative ETFs is only likely to expand. Our ETF Impact Survey found that more institutional investors globally plan to increase their allocations to alternatives than bond exposures (45 percent versus 38 percent, respectively).8 US advisors seem to be on a similar page, as we found that 4 in 10 US advisors plan to advise their clients to increase allocations to alternatives over the next year.9
The increased adoption will be partly driven by regulatory frameworks creating a more conducive environment for new active ETFs to come to market, and increased comfort in using the structures already in market as track records/case studies are built, but also from an investment need.
Traditionally diversified portfolios are facing diversification headwinds, given that traditional cross-asset correlation relationships have broken down, stock contribution to risk is climbing and equity portfolios have never been more concentrated.
