Exchange-traded funds have become increasingly popular over the past few years as they continue capturing market share from mutual funds. As a testament to the strength of these trends, ETFs experienced net inflows during 2022 despite the S&P 500’s nearly 20% decline and the more than 10% drop in the Bloomberg U.S. Aggregate Bond Index.
Despite these surprising and persistent inflows, some experts believe niche ETFs could be in trouble this year. The economy is likely headed toward a recession, meaning stocks could see more downside. At the same time, there’s growing competition from niche issuers and established firms converting existing mutual funds.
Let’s examine why active ETFs could continue outperforming despite these trends and what that means for investors.
See our Active ETFs Channel to learn more about this investment vehicle and its suitability for your portfolio.
Why Active ETFs Could Outperform
Active ETFs grew by $121 billion to reach $341 billion in 2022. While that’s less than 5% of all ETF assets, active funds captured an eye-popping 14% of total net ETF inflows last year, making them the fastest-growing subset of the ETF space. And these trends show no signs of slowing in 2023 despite the challenging market conditions.
Of course, most of the spectacular growth in active ETFs stems from mutual fund conversions, bringing existing assets along with them. For example, JPMorgan converted four mutual funds into active ETFs last June, bringing approximately $9 billion in assets into the fold. These moves capture market share from mutual funds, not other ETFs.
These trends are likely to continue moving into 2023. In fact, JPMorgan alone plans to convert another $2 billion worth of mutual funds into active ETFs this year. Many other firms have similar plans to convert billions of dollars worth of conventional mutual funds into active ETFs to meet investor appetite and reduce tax exposure.
But still, these conversions are just a drop in the bucket. For instance, JPMorgan has over $800 billion in mutual fund assets. Total mutual fund assets stand at roughly $27 trillion, compared to just $7 trillion in ETFs and $400 billion in active ETFs. These figures suggest that active ETFs have a lot of room to grow as conversions accelerate over time.
What’s Next for Active ETFs?
Active ETFs could also see a boost from innovative new strategies. While single-stock ETFs and other speculative strategies outperformed in 2022, risk management strategies could drive growth in 2023.
For example, bear market ETFs, like the AdvisorShares Ranger Equity Bear ETF (HDGE) could help investors hedge their overall portfolio against market declines. Meanwhile, income-focused funds, like the Nationwide Russell 2000 Risk-Managed Income ETF (NTKI), could help generate income while reducing risk through option collars.
Investors may also seek out active ETFs with a long track record of success to reduce risk. For example, mutual fund conversions bring extensive track records from the mutual fund world into the ETF space. As a result, passive ETFs could lose market share as investors seek experienced managers to navigate the bear market.
The Bottom Line
Exchange-traded funds have become increasingly popular over the past few years, but niche issuers could see some challenges in 2023. With a bear market and recession on the horizon, investors could shift away from bull market-focused and niche passive ETFs. However, the active ETF segment appears well-positioned to continue to grow in 2023.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.
