Active ETFs surge forward

An investment “wrapper” long affiliated with index funds is showing what else it can do.

In the decades since their introduction, exchange-traded funds – or ETFs in the initialism-obsessed investing industry – have become a mainstay of the modern investment landscape. Like mutual funds, they offer a way to invest in a large number of financial assets without needing to buy dozens – or even hundreds – of individual stocks, bonds or other securities.

When most investors think of ETFs, however, they think of the mannerly world of passively managed funds, portfolios guided by rigid rules rather than on investment managers’ individual skill. So-called “index funds” are one type of passively managed fund, described as such because they attempt to mirror the performance of a particular market index. The three largest ETFs, based on assets under management, are designed to track the S&P 500 index.

Recently, however, a newer class of ETF has been gaining momentum with investors: active ETFs. Fund sponsors are responding to this demand, introducing a bonanza of new products. Unlike their passive fund peers, active fund managers base their day-to-day investment decisions on things like technical and fundamental analysis, industry research and sometimes a dash of good ol’ gut instinct.

If a passive fund is designed to go with the flow of the market, its opposite would be an active fund that sets its ambitions on beating the market. Not that beating the market is the only available goal for active ETFs – they can also be managed for income generation or risk management, as examples.

The building blocks of an ETF

Starting with the basics: An ETF is an investment vehicle that bundles many assets into a single share, like a carefully arranged bouquet of investments. Instead of picking and buying each flower individually, investors can purchase a bouquet representing different stocks, bonds or commodities at once, gaining exposure to a variety of assets or companies.

If you think this sounds awfully similar to a mutual fund, you’re right. The similarities are such that some investment pros refer to mutual funds and ETFs as “wrappers,” like the paper around the bouquet. However, there are some key differences:

• ETFs are listed on public exchanges, like the New York Stock Exchange. Mutual funds are bought and sold directly through fund sponsors.
• ETFs are priced continuously throughout the day, just like a publicly listed stock. Mutual funds are priced once per day.
• On account of how the funds buy and sell assets and create or delete shares, taxes are assessed differently. This make ETFs more tax efficient in most cases.
• Mutual funds require minimum investments, typically between $500 and $5,000. But, if you can afford one share of an ETF, you can invest in that ETF.
• ETFs have a reputation for having lower fees, though it’s not universal.
• ETF fund sponsors have to publish their investment allocation every day. Mutual funds have to disclose every quarter. This has some interesting implications, covered later.

For a long time, mutual funds had an advantage over ETFs: While both could ably support passive investment strategies, only mutual funds could offer active management. That changed in 2008. Following rule changes from the U.S. Securities and Exchange Commission, Bear Stearns introduced the world’s first active ETF strategy. Savvy idea; bad timing. Unrelated to its ETF innovation, Bear Stearns collapsed later that year with the US housing market.

Passive roots, active ambitions

If you like unsolvable questions, and you like investing, you’re going to love the debate over active versus passive management.

Passive advocates will say, “You can’t reasonably expect to make the right investment decisions day-in and day-out. The market’s too complex. Matching the market is good enough.” The active gang is more likely to say, “When you go against the grain, sometimes you can be strong when everyone else is weak, and those opportunities can make all the difference.”

Fees are another point of difference. Since active management involves hands-on, day-to-day decision-making, investment fees tend to be higher. Researchers and analysts don’t work for free. Passive investing, on the other hand, takes an approach that pays a lot less attention to the daily, quarterly and yearly trends of the market. With all its investment decisions baked in at the inception of the fund, this saves money on transaction costs and personnel, so investment fees tend to be lower.

Perhaps surprisingly, considering the go-fast reputation of Wall Street in the period when it took root, passive investing is the newer invention. Its story starts with the creation of modern portfolio theory by Harry Markowitz in 1952, an idea that earned him the Nobel Memorial Prize in Economics Sciences in 1990 but ended up changing investing much sooner than that. Brokerages began introducing mutual funds and index investing in the 1970s as investors embraced the idea of diversified portfolios riding broad, long-term growth trends.

One of the champions of this approach was John Bogle, whose investment brokerage Vanguard introduced one of the earliest index mutual funds, tracking the S&P 500. (Passionate adherents of Bogles’ low-fee, passive index fund investing approach proudly call themselves Bogleheads – fun fact, dull parties.)

Throughout this time, we also saw advances in trading technology and financial engineering. Amid this period of innovation, the Toronto Stock Exchange effectively created a proto-ETF in 1990 based on the performance of the 35 largest companies it listed. Three years later, State Street Global Investors launched its S&P 500 Trust ETF, the first US ETF, which is still in operation today.

The market grew steadily from just a few funds in the mid-1990s to more than 4,000 as of 2026, with trade of ETFs representing around a third of daily trading volume in US public exchanges.

Active ETFs arrived in 2008, but the Great Recession happened, and when the historic bull market charged through the 2010s, investors leaned into passive management. The volatile market of the 2020s then helped make the case for active management (and private market investing, incidentally) as a growing number of investors have sought ways to differentiate their returns from macroeconomic forces. And ETFs, on the strength of their tax efficiency, have increasingly gained market share.

The future of funds

Does this mean active ETFs are destined to dominate the market? Are mutual funds old hat? Not quite.

For one, mutual funds have some built-in advantages. Large retirement plans cannot invest in ETFs on account of certain operational limitations related to how frequently assets are priced. Institutional plan managers also tend to be more comfortable listing funds with long track records and are large enough to yield benefits of scale. Active ETFs haven’t had the time to prove their resilience.

Additionally, mutual fund sponsors, working in a closed ecosystem, benefit from working with a semi-captured audience. Combined with a mature communications infrastructure, it’s easier for them to maintain regular communication with investors and their financial advisors.

On the supply side of the equation, some have made a case for the benefits of discretion. Mutual funds are required to disclose their holdings within 60 days of the end of a quarter, giving fund managers the opportunity to make moves without shouting them from the rooftops. Active ETF managers, on the other hand, need to disclose their investment allocations on a daily basis. ETF advocates cite this as a clear strength of their wrapper – what you see is what you get.

But if you are an ace fund manager with a reputation for greatness and the fees to match, wrapping your fund in an ETF means you have to share the recipe of your secret sauce every day.

Whether these advantages are enough to change the evolving balance of power is yet to be seen, but this much is clear: Investors have more active management options than before. What comes next is up to investors to decide.

Sources: U.S. Security and Exchange Commission, Morningstar

Investors should consider the investment objectives, risks, and charges and expenses of mutual funds and exchange traded funds carefully before investing. The prospectus contains this and other information about these investments. The prospectus is available from your financial advisor and should be read carefully before investing.

There is no assurance that any investment strategy will be successful, and an investment could lose money. Past performance is not indicative of future results. Diversification does not guarantee a profit nor protect against loss. Commodities are volatile investments and should only form a small part of a diversified portfolio. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. The S&P 500 is an unmanaged index of 500 widely held stocks and cannot be invested in directly. Raymond James is not affiliated with any individuals or organizations mentioned.