How active ETFs could help investors navigate recent wild swings in the stock market

MW How active ETFs could help investors navigate recent wild swings in the stock market

By Isabel Wang

Active ETFs are mushrooming, but most assets are flowing to big managers

Hello! This is MarketWatch reporter Isabel Wang bringing you this week's ETF Wrap. In this week's edition, we look at actively managed ETFs, just in time for Thursday's dramatic drop - and partial recovery - to help illustrate why recent selloffs in U.S. stocks can also create opportunities.

Please send tips or feedback to isabel.wang@marketwatch.com or to christine.idzelis@marketwatch.com. You can also follow me on X at @Isabelxwang and Christine at @CIdzelis.

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Several U.S. megacap technology companies have come under pressure in recent weeks, making room for other stocks on their way up, which some market analysts say is a sign of improving breadth that creates opportunities for active exchange-traded funds.

On Thursday, the equity selloff hit Meta Platforms Inc. (META) particularly hard, with its shares ending 10.6% lower, as investors parsed its tepid earnings guidance, the release of a worse-than-expected first-quarter GDP print and signs of persistent inflation pressures.

While technology-related sectors were the worst performers in the market, some of the previously lagging sectors stood their ground. The S&P 500 utilities XX: SP500.55, energy XX: SP500.10 and materials sectors XX: SP500.15 were the best performing sectors on Thursday, up 0.3%, 0.5% and 0.7%, respectively, while the communication services XX: SP500.50 sector slumped 4%, according to FactSet data.

The S&P 500 equal-weighted index XX: SP500EW was up 0.2% on Thursday, while the index's market-cap-weighted version SPX finished 0.5% lower, according to FactSet data.

Aniket Ullal, head of ETF data and analytics at CFRA Research, said that when a few megacap heavyweights drive all the returns in the stock market, it's "much more challenging" for active ETFs to beat the indexes or other passive funds targeting the benchmarks.

However, if the breadth starts returning to the market, "that creates opportunities for active managers because they can essentially swim and fish in a larger pool [of equities]," he told MarketWatch in a phone interview on Thursday.

When weathering market volatility, rather than relying on an indexed product to gain exposure to the overall market, active ETFs can provide investors with tools that allow them to take a "more targeted approach" to specific sectors, strategies or themes that exhibit less volatility, said Kirsten Chang, senior industry analyst at VettaFi.

"It can often allow them [investors] to navigate around the wild swings with specific criteria or parameters," Chang told MarketWatch on Thursday.

ETFs present a growth opportunity for active managers

Active ETF strategies have taken the industry by storm over the past five years, and the sector is growing at a dizzying pace.

In 2019, when the U.S. Securities and Exchange Commission approved a rule change streamlining the fund listing process and giving portfolio managers more flexibility to create ETF shares, the active ETF category represented only 2.1% of $3.8 trillion in the U.S. ETF assets. Since then, the active ETF universe has grown by over 20% each year, pushing its share of the ETF market to 7% by the end of March 2024, according to Morningstar Research Services.

Traditional mutual-fund companies have also begun launching active ETFs or converting their existing funds to ETFs, but the size of the active ETF market still pales in comparison with the active mutual-fund market, underlining the massive opportunity for these products, a team of Morningstar analysts led by Bryan Armour, director of passive strategies research for North America, said in a Tuesday report.

Actively managed mutual funds claimed more than $13 trillion in assets by the end of 2023, nearly 25 times more than active ETFs' $530 billion, according to data compiled by Morningstar.

Flows and growth rates suggest active ETFs are becoming "an increasingly large thorn" in active mutual funds' side, highlighting the urgency for legacy mutual-fund managers to embrace the ETF wrapper, the analysts said.

Active ETF isn't a panacea for fund managers

Active ETFs are a growth opportunity for active fund managers, but only a few have been able to take full advantage, so far.

The top 10 ETF issuers controlled 74% of assets under management in the active ETF market, while the rest of the 320 providers with launched active ETFs having "very limited success," Morningstar analysts said. The below chart drives the point home.

"The same factors that decide fates across the investment industry determine active ETFs' winners and losers - performance, breadth of offerings, and most importantly, fees," Armour told MarketWatch in a follow-up interview on Thursday.

Funds in the cheapest quintile of active ETFs sector hold more than $325 billion in assets, while the most expensive quintile holds just $35 billion. In addition, about half of active ETF assets fall in the cheapest quintile, while over 75% of assets sit in the cheapest two quintiles, Morningstar analysts said in the report.

"It's [the active ETF landscape] in its infancy. There's a huge opportunity for active managers because active ETFs have a lot of advantages, but that doesn't mean that launching an active ETF automatically means success," Armour said.

As usual, here's your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.

The good...

   Top performers                                                                                                                                                                         %Performance 
   KraneShares CSI China Internet ETF                                                                                                                                                     9.0 
   YieldMax TSLA Option Income Strategy ETF                                                                                                                                               8.1 
   SPDR S&P Regional Banking ETF                                                                                                                                                          6.3 
   iShares U.S. Regional Banks ETF                                                                                                                                                        6.2 
   Invesco China Technology ETF                                                                                                                                                           6.1 
   Source: FactSet data through Wednesday, April 24. Start date April 18. Excludes ETNs and leveraged products. Includes NYSE-, Nasdaq- and Cboe-traded ETFs of $500 million or greater. 

... and the bad

   Bottom performers                      %Performance 
   AdvisorShares Pure U.S. Cannabis ETF   -4.6 
   abrdn Physical Platinum Shares ETF     -3.8 
   iShares Silver Trust                   -3.7 
   abrdn Physical Silver Shares ETF       -3.7 
   Global X Copper Miners ETF             -3.5 
   Source: FactSet data 

New ETFs

YieldMax Tuesday announced the launch of the YieldMax$(TM)$ Bitcoin Option Income Strategy ETF YBIT, which seeks to generate current income via a covered-call strategy on one or more select U.S.-listed exchange-traded products that seek exposure to Bitcoin. Calamos Investments on Monday announced the planned launch of 12 so-called "structured-protection" ETFs which seek to provide 100% downside protection and equity upside to a predetermined cap over one-year outcome periods. The suite of funds are designed to offer exposures to the S&P 500, Nasdaq-100 and Russell 2000, the firm said in a press release.

Weekly ETF Reads

Long-term Treasury bond ETFs under pressure as investors weigh GDP report (MarketWatch)'Irrational excitement' over AI will wipe out tech stocks, says contrarian investor who has nailed prior selloffs (MarketWatch)Transportation stocks sink, with industry ETF on track for biggest drop since October (MarketWatch)New Stock ETFs Offering '100%' Downside Protection Are Coming (Bloomberg) Hong Kong Crypto ETF Launches Will Test Ambition to Be Digital-Asset Hub (Bloomberg)JPMorgan AM surges to dominance in Europe active ETF market (Financial Times)

-Isabel Wang

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April 25, 2024 17:31 ET (21:31 GMT)

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