Active ETFs Are Poised to Continue in 2025. What Does It Mean for Wall Street?

Wall Street asset managers are increasingly relying on actively managed exchange-traded funds (ETFs) to bolster revenue growth and sustain profit margins. However, the dynamics of this market differ significantly from traditional stock-picking strategies.

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Historically, ETFs have been synonymous with low-cost passive investing, dominating the space by holding the majority of assets. Yet, active ETFs have been making significant strides, accounting for 27% of net inflows and 77% of new ETF launches in 2024, according to data from JPMorgan Asset Management.

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A pivotal change occurred in 2019 when the U.S. Securities and Exchange Commission revised rules governing ETFs. This regulatory shift enabled active management to thrive within the ETF structure, prompting asset managers to establish their ETF offerings or convert mutual funds into ETFs.

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"ETF conversions can halt outflows and attract fresh capital," explained Jared Woodard, ETF strategist at Bank of America, in a recent client note. He highlighted that 121 active mutual funds have transitioned into ETFs so far. Before conversion, the average fund experienced outflows of $150 million over two years. Post-conversion, the same funds saw inflows averaging $500 million.

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Although it’s challenging to determine how much of this growth stems from genuine interest in active ETFs versus the migration away from mutual funds, success in this space offers asset managers a chance to retain fee revenue. Passive investing’s growing dominance has exerted downward pressure on fees, making active ETF growth particularly valuable.

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The momentum behind active ETFs is expected to continue into 2025. Woodard predicts mutual fund conversions worth $3 billion next year and notes that numerous asset managers are seeking SEC approval to add ETF share classes to their mutual funds.

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"The market is loudly and clearly favoring actively managed strategies within ETFs," said Johan Grahn, head ETF market strategist at Allianz Investment Management.

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The rise of active ETFs doesn’t mirror traditional stock-picking methods. Many successful products focus on offering unique strategies rather than merely trying to outperform the S&P 500.

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For instance, JPMorgan’s Equity Premium Income ETF (JEPI) and Nasdaq Equity Premium Income ETF (JEPQ) have gained popularity due to their blend of stock-picking and income generation through options trading. These income-focused strategies, along with buffer funds designed to manage risk, appeal to investors seeking tailored outcomes. By using derivatives to manage potential risks and returns, these funds sell predictability as an attractive feature for investors.

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"The industry has long sought ways to challenge passive investing but found limited success. Now, by offering essentially passive strategies with customizable elements to match individual goals, it’s been a game-changer for active ETFs," said Matt Collins, head of ETFs at PGIM Investments.

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Other active stock ETFs have also carved out a niche. The iShares U.S. Equity Factor Rotation Active ETF (DYNF), for example, has attracted more than $11 billion in inflows this year, according to FactSet. Instead of focusing solely on long-term winners, DYNF capitalizes on trends in quantitative factors, often complementing passive funds in model portfolios.

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As Woodard noted, "The most successful active conversions provide unique market access or strategies with fewer competitors, including ‘quantamental’ equity, high-yield fixed income, thematic funds, and options strategies."

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Identifying high-potential areas for active ETFs is critical for fund issuers, as distinctive strategies can command higher fees and avoid the fee wars common in the passive ETF space.

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Fixed income represents a promising avenue for active ETFs. While fixed income accounts for roughly 75% of the broader bond market, the ETF segment is still dominated by passive funds. Jon Maier, chief ETF strategist at JPMorgan Asset Management, believes the complexity of bond investing positions active management for significant growth in this sector.

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A standout performer in this space is the Janus Henderson AAA CLO ETF (JAAA), which brought in about $11 billion in 2024, per FactSet. The fund achieved a 7.3% year-to-date return through late December, outperforming broad bond market benchmarks.

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Another area of interest is artificial intelligence (AI), which defies traditional sector classifications and is likely to evolve as technology advances. Active stock-picking could help investors navigate this fast-changing trend. The AB Disruptors ETF (FWD) is an example of success in this category, featuring top holdings like Nvidia and Vistra Corp. The fund outperformed the Nasdaq 100 in 2024 and garnered over $200 million in inflows.

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"What makes this exposure attractive is that it doesn’t focus exclusively on one theme," said Noel Archard, global head of ETFs at AllianceBernstein.

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As actively managed ETFs continue to gain traction, they’re reshaping the ETF landscape by blending innovation with adaptability. Whether in fixed income, equity income, or thematic strategies, these funds offer investors new tools to meet their goals, signaling a dynamic shift in how Wall Street approaches asset management.

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