For many of us, ETFs have been synonymous with passive management. Since the early 1990s, ETFs have followed in the footsteps of the most well-known passive ETF — the S&P 500 ETF Trust (SPY). And even today, ETFs have a reputation for their accessibility and simplicity.
Recently, active management has brought another layer of evolution (with potentially higher returns) to the ETF world. As a result, active ETFs have seen rapid development. Most new ETF launches are now active ETFs. In fact, out of the 300+ ETFs launched this year, less than 10% are passive ETFs. We shouldn’t, however, confuse passive management with passive ideas. Passive management (i.e., index investing) continues to innovate and simplify complex investment ideas through factor-based and other proprietary weighting methodologies. It also provides investors access to new or niche asset classes, and redefines evolving industries.
Passive ETFs Do Not Lack Conviction
One of the most common misconceptions has been that active ETFs equal innovation, while passive ETFs equal neutrality. After all, most passive ETFs track indexes as part of investors’ long-term holdings. These “set and forget” strategies are straightforward, broad categories. These ETFs can have a relatively simple methodology, like the S&P 500, which is weighed by market capitalization. This is one of the biggest benefits of many ETFs — they are straightforward and work efficiently. That makes them attractive to retail investors. But it is easy to start viewing passive ETFs as “passive” in other senses. In other words, passive investing doesn’t mean investing without a strong investment thesis or investing in “plain vanilla” due to lack of ideas.
Passive ETFs and their indexes can also be innovative and support new strategies. Many use alternate weighting schemes like revenue or factor weighting. These indexes may also incorporate exclusions to create a more “active” feel. Many also use advanced optimization and other technology to run scenarios. And, finally, there are still plenty of passive ETFs that thrive in the disruptive technology space and play an important role in defining new industries or asset classes. This includes anything from thematic equities (new disruptive industries) to emerging asset classes that may be difficult to invest in outside of the ETF structure (e.g., digital assets and private markets).
Active ETFs Growing in Popularity, But Have Pros and Cons Relative to Passive ETFs
Active ETFs are managed by portfolio managers who try to outperform a benchmark index. This gives them more flexibility than traditional index funds. That flexibility can be helpful, especially in volatile markets where a flexible strategy may capture short-term opportunities. But it can be a double-edged sword. Active decisions can also lead to emotional investing or straying from a long-term strategy. Because of the added layer of management, these funds tend to come with higher expense ratios. And while investors are paying for that expertise, it doesn’t guarantee outperformance. Many active strategies still fall short of passive benchmarks over time.
Passive ETFs: Examples of Innovation
There’s still a lot of innovative ideas in passive ETFs, despite the lack of launches. The following includes just some of the examples of passive ETFs launched this year.
Factor and Other Proprietary Weighting Schemes
There have been several ETFs with fresh takes on older ideas. The Alger Russell Innovation ETF (INVN), for instance, focuses on undervalued innovative companies by starting with the well-known Russell 1000 Index, removing the bottom one-third of stocks by trailing twelve-month free cash flow margin, and ranking the remaining stocks by the amount each company spends on research and development as a percentage of its enterprise value.
Similarly, Global X released two ETFs this year which were very relevant in the current tariff environment. The Global X S&P 500 Revenue Leaders ETF (EGLE) and the Global X S&P 500 US Market Leaders Top 50 ETF (FLAG). EGLE tracks an index which targets S&P 500 companies that draw at least half their revenue from domestic sources. Similarly, FLAG also tracks U.S. revenue-focused companies, but selects a narrower pool of 50 market leaders.
Franklin has launched two ETFs — the Franklin U.S. Dividend Multiplier Index ETF (XUDV) and Franklin International Dividend Multiplier Index (XIDV). These ETFs track broad equity indexes and aim to provide a dividend yield of two or three times that of the parent index. While the multiplier may make it sound similar to leveraged products, these ETFs are not leveraged and do not use derivatives. The underlying indexes are balanced against volatility and concentration risk using a three-stage optimization process where thousands of simulations are run against market universes.
Access to New or Niche Asset Classes (Including Crypto)
On the crypto front, several products have been released, including the Bitwise Bitcoin Standard Corporations ETF (OWNB), which tracks an index of equities of corporations that hold at least 1000 bitcoin on their balance sheet and embrace bitcoin as a strategic reserve asset. I did a more in-depth review of crypto launches so far this year, which includes both active and passive ETFs, here. As shown in the figure above, spot crypto ETFs (also a form of passive ETF) have driven increased assets in passive ETFs.
The Pacer PE/VC ETF (PEVC) tracks a liquid index of publicly traded securities that replicate the risk and return characteristics of the U.S. private equity (PE) and venture capital (VC) industries. This involves optimizing exposure between two PE and VC indices at a lower cost than traditional private market funds (PEVC has an 85 basis point expense ratio).
Thematic: Defining New Industries
Several faith-based ETFs were also launched this year, including the JLENS 500 Jewish Advocacy US ETF (TOV). This ETF tracks an index that screens for companies that do not align with Jewish values, and the remaining companies are scored on their performance on three Jewish value scorecards.
Additionally, newer areas like electrification have grown in popularity due to trends in artificial intelligence. The ALPS Electrification Infrastructure ETF (ELFY) is one example of the new electrification theme. ELFY’s holdings are about 39% utilities, 31% industrials, 14% technology, and 13% energy. While thematic ETFs are often compared to industry ETFs, which generally follow GICS (or similar) classification standards, many thematic ETFs are multi-sector. The thematic indexes behind these ETFs help define these new multi-sector industries — or themes — and can create a roadmap that goes beyond traditional sector and industry classifications.
Bottom Line
While active ETFs have been gaining popularity, passive ETFs continue to play a critical role — not just as core building blocks in portfolios, but also as tools to gain exposure in emerging asset classes and disruptive industries.
For more news, information, and strategy, visit ETF Trends.
VettaFi LLC (“VettaFi”) is the index provider for TOV, XUDV, XIDV, and ELFY, for which it receives an index licensing fee. However, TOV, XUDV, XIDV, and ELFY are not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of TOV, XUDV, XIDV, and ELFY.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out some of our webcasts.
More Liquidity Topics >
