Why active ETFs saw a record year in 2023

According to research from Morningstar, 2023 saw the most active ETF launches of any year. The print also revealed that active ETFs had over $500 billion in assets under management by the end of the year, though they still represent just 6% of the ETF sector.

Morningstar Research Senior Analyst Daniel Sotiroff joins Yahoo Finance to explain why investors should consider adding active ETFs to their portfolios.

Sotiroff shares his thoughts on the leaders in active ETF management: "When you look at the active ETF space, it's really kind of dominated by a couple of firms. They're kind of the ones that we already know about. Think of like Dimensional Fund Advisors (DUHP), they've been out there for about four decades. They're kind of a blend between active and passive. They kind of pull from both to kind of build portfolios. They're really having the most success in terms of gathering assets out there. They have broadly diversified low cost portfolios so that kind of folds into the performance story at the end of the day. On the more discretionary, Capital Group and Fidelity are coming out with portfolios. What they're kind of doing is it's kind of cloning mutual fund offerings that they already have. They are built on great long-term strategies."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Nicholas Jacobino

Video transcript

AKIKO FUJITA: While active ETFs are continuing to gain in popularity, according to Morningstar Research, 2023 saw the most active ETFs launches than any other year. By the end of the year, active ETFs had more than $500 billion in assets under management. But they still only make up about a small segment of the ETF space, roughly 6%.

So why is it a good strategy for you to consider? Let's bring in our guest Daniel Sotiroff, Morningstar Research senior analyst, to discuss more. This is part of ETF report brought to you by Invesco QQQ.

Good to talk to you today. Walk us through the case here. A lot of investors looking at new ETF plays. Why are active ETFs the way to go?

DANIEL SOTIROFF: So it really depends on the investor. I think, at the end of the day, the single biggest advantage of active ETFs is just it's the ETF. It's this very tax efficient vehicle at the end of the day. And a lot of active managers have really been relegated more toward mutual funds.

We're starting to see that change a lot over the last couple of years. One, is, I think, ETFs are just gathering a lot of assets for that tax efficiency. So they've been stiff armed into it, if you want to think of it that way. They've got to move to the ETF vehicle in order to compete with the traditional passive ETF options that we have out there.

Think of those from like, Vanguard and BlackRock that have just been hoovering up a lot of money over the last decade or so. And then the other advantage is now, you can be in the ETF. And you can potentially still get access to an active manager that you may really like at the end of the day.

So you can have your cake and eat it too, I guess, if you're really into active management.

RACHELLE AKUFFO: And so for people who aren't familiar with actively managed ETFs, so the goal was instead of just tracking the movements of the market, you're actually trying to beat that benchmark. What have been some of the top performing ones? The ones that you've seen the biggest inflows, especially, over the past few months.

DANIEL SOTIROFF: Yeah, great question. So when you look at the active ETF space, it's really dominated by a couple of firms. And they're the ones that we already know about. So think of like, Dimensional Fund advisors. They've been out there for about four decades. They're a blend between active and passive. They pull from both to build portfolios.

They're really having the most success in terms of gathering assets out there. And they have broadly diversified, low cost portfolios. So that folds into their performance story at the end of the day.

On the more discretionary active side, we're seeing like Capital Group and Fidelity are coming out with portfolios. And really, what they're doing is it's cloning mutual fund offerings that they already have. So they're built on great long-term strategies. They're using the same management teams there that we have a lot of confidence in. I think across a lot of asset classes.

So those are really the winners. I think are more of the entrenched parties out there that already have a really strong mutual fund lineup. Outside of that, it's really scattered. You're seeing a lot of things like covered call strategies, single stock ETFs, A lot of things that are built around derivatives and stuff. And, occasionally, you'll see one, take off or get really popular. But they're few and far between.

It's really more of like, the Capital Groups and Dimensional Fund advisors at the end of the day that have been the most successful, I should say, to date.

AKIKO FUJITA: Daniel, what are some of the other ETF plays you're watching? Certainly, a lot of investors looking to maybe increase exposure in that direction, just given the choppiness that we've seen in the market recently. How would you advise them?

DANIEL SOTIROFF: Yeah, great question. So one of the ETFs I think I sent over to you today was Vanguard core bond ETF. The ticker is VCRB. That's a brand new actively managed ETF from Vanguard that they just launched in December.

So if you're looking to control risk a little bit, because we have been in very choppy markets over the last couple of years, that's a great option. General expectations on that, it's going to be very, very similar to something that you would get from BND or AGG at the end of the day. Something that just tracks the broader bond market.

But Vanguard's in-house managers, basically, what they're going to do is take on some incremental risk namely in the form of credit risk at the end of the day. So over a long holding period, you'll get a slightly better return than the broader bond market.

And, again, this is Vanguard's behind it. They got a great fixed income group that's managing this. And true to Vanguard's name. This is a very low cost offering at the end of the day. So it's a great option for anyone who's trying to take risk off the table, or maybe manage this as a core component of a broader portfolio.