Active ETFs: A Powerful Tool, Not a Total Portfolio Solution

However, active ETFs may not be the panacea that investors and Wall Street hope for.

That’s because returns for active management have continued to be mixed, with many managers still underperforming their benchmarks over the long haul — especially in several equity sectors. For investors and advisors, it’s best to think about active ETFs as a tool rather than just a one-and-done proposition.

Active ETFs debuted in 2008, but it wasn’t until recently that the number of active ETFs on the market took off. The reasons have been vast. Many of these came from SEC regulation changes under new Rule 6c-11.

New semi- and non-transparent structures, which allowed managers to keep their “secret sauce” hidden to prevent front-running, allowed more investment shops to feel comfortable in the structure. Mutual fund-to-ETF conversions instantly provided new growth and share launches. Copycat fund launches of existing mutual funds using the same managers and styles also boosted growth. As a result, active ETFs have transitioned from being a niche product to a significant contender in the investment vehicle landscape.

The results have been more than impressive.

The number of active ETFs has grown from a small handful of active products in 2008 to nearly 1,800 by the end of 2024. Today, the number of active ETFs on the market exceeds the number of passive ones and more than $1 trillion in investor assets are tucked away in actively managed ETFs.

Investors, big and smal, have been impressed by the potential, as have financial advisors. Thanks to lower costs, tax benefits, and intraday tradability, active ETFs continued to be added to portfolios and models with gusto.

However, investors, model makers, and institutions may not want to rubber-stamp active ETFs and simply add them to their portfolios without thinking about it. While it turns out that the lower cost structure of ETFs helps managers overcome the fee hurdle more easily, performance for active management still remains mixed.

The whole point of choosing an active ETF is alpha generation, which is excess returns beyond a benchmark. With a passive or index, what you see is what you get. However, active management aims to outperform a benchmark and generate excess returns for a portfolio. Looking at the results, active management continues to struggle in many categories.

That’s the gist, according to S&P Dow Jones Indices’ latest SPIVA (S&P Indices versus active) report for 2024. According to the report, 65% of active large-cap U.S. equity funds managed to underperform the S&P 500. That’s worse than the 60% rate of 2023, but slightly above the 64% average annual rate over the 24-year history of the SPIVA. ¹

And it’s not just large-cap equity funds, S&P Global found that over the 15-year period ending December 2024, there were no categories in which a majority of active managers outperformed.

This table sums up their findings and the individual breakdown of various categories of funds.

Source: S&P Global Dow Jones Indexes

What’s particularly troubling, according to S&P researchers is that the opportunities for additional alpha were present during much of last year. The report measured sector dispersion, which rose for the back half of the year. This environment would have been ripe for active managers to prove their trade and choose better-performing equities among the wreckage or change style to suit the market’s conditions. However, S&P noted that performance through this period was mixed.

So, what does the SPIVA report mean for active ETFs and our portfolios? Well, the easy answer is that many issues with active management in a mutual fund or other fund wrapper may still be present in an ETF. It can be hard to pick the right stocks at the right time.

But that doesn’t mean you can’t use active ETFs. We just have to use them in a different way.

Rather than using them for our entire portfolios, using them in concert with passive funds could provide the best strategy for portfolios. Especially, if investors focus their active ETF holdings on those sectors and asset classes that really work.

Looking at the SPIVA data, large-cap exposures continue to favor indexing. However, in the world of small-cap and mid-cap equities, active management can play a significant role in delivering alpha. By using a passive small-cap index fund with an active ETF, investors can potentially grab additional gains or returns. Likewise, in emerging markets or fixed-income portfolios.

The key for SPIVA is that the winners are sector or market-cap niches with plenty of market inefficiencies to exploit. It’s here that managers can actually make a difference in alpha generation.

In addition, betting on one horse may not make sense, as the SPIVA report shows that outperformance inconsistency remains. That means potentially using two active ETFs in a category to reduce manager risk and create diversification.

These ETFs are sorted by their YTD total returns, which range from -2.7% to 9.7%. They have expense ratios between 0.17% and 0.36% and assets under management between $5B and $30B. They are currently yielding between 0.8% and 9.7%.

Overall, the growth of active ETFs has been swift, with hundreds of funds launching and assets surpassing a trillion dollars. However, while investor and Wall Street enthusiasm is high, the results for active ETFs have been less so. Underperformance persists among many ETFs. That could mean that active ETFs are more of a tool to work in the context of a whole portfolio, including passive funds, rather than being the whole portfolio.

Active ETFs may not be the silver bullet many investors hope for. While some funds do outperform, many are still struggling to generate additional alpha. And in that, they may not be a comprehensive portfolio solution like their growth suggests. Investors need to use them as a tool rather than a total portfolio option.

¹ S&P Global (April 2025). SPIVA U.S. Scorecard 2024