More Bond ETFs, Fewer Passive ETFs, and What Else to Expect in the New Year

More Bond ETFs, Fewer Passive ETFs, and What Else to Expect in the New Year

Predictions for the Future of Exchange-Traded Funds (ETFs) in 2024

As we enter the new year, exchange-traded funds (ETFs) are poised to continue their success from 2023. Despite the impressive performance and increased flows seen in the ETF market last year, there were several emerging trends that went unnoticed. Looking ahead, the members of Morningstar’s North America passive strategies team have come together to offer their predictions for what investors can expect in the ETF landscape in 2024. From the rise of active ETFs to the potential closure of underperforming funds, here are the key trends to watch out for.

Prediction 1: Active ETFs Become the Preferred Choice for Alpha-Seeking Investors
Over the past few years, the market for strategic-beta ETFs has become saturated, leading to fewer launches and more closures. In contrast, actively managed ETFs, covered-call ETFs, and defined-outcome ETFs have gained traction among investors seeking alpha. This trend is expected to continue in 2024, with smaller providers finding new opportunities in the higher-priced active and alternative ETF space. As a result, the number of strategic-beta ETF launches may decrease, while active and alternative ETFs attract more assets.

Prediction 2: ETF Closures Will Increase
Despite the continuous influx of new ETF launches, many of these funds struggle to gain significant traction. With over 3,300 ETFs currently available to U.S. investors, more than 1,200 of them have less than $50 million in assets. These underperforming funds are likely candidates for closure as the costs of maintaining them outweigh the revenue generated. In 2024, we can expect to see an increase in ETF closures as providers reevaluate their product offerings.

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Prediction 3: Bond ETF Launches and Flows Accelerate, Led by Active ETFs
The market for U.S. taxable-bond ETFs is significantly smaller than the equity ETF market. However, as investor demand for bond ETFs continues to grow, major players in the industry will aim to bridge this gap. The adoption of the ETF Rule in 2019 has made bond ETFs more operationally efficient, and investors have become more comfortable with these funds, especially after their resilience during the COVID-19 pandemic. In 2024, we can expect to see an increase in bond ETF launches, particularly in the actively managed space.

Prediction 4: Alternative ETFs Will Pick Up Steam
The ETF market is saturated with stock and bond strategies, leaving little room for alternatives. However, this is expected to change in 2024 as providers recognize the potential in this untapped market. Hedge-fund-like strategies such as multistrategy, systematic trend, and market-neutral are likely to be the focus of new ETF launches. Investors have become more aware of the benefits of ETFs and are ready to embrace alternative strategies packaged in an ETF wrapper.

Prediction 5: Covered-Call ETFs Will Lose Steam
Covered-call and defined-outcome strategies have been popular in the ETF space since 2021. However, this trend is expected to slow down or even reverse in 2024. While these strategies offer added yield and downside protection, they come with a trade-off in terms of upside potential. Investors are becoming more aware of the opportunity cost associated with these options-based ETFs, as they often miss out on significant market rallies. Additionally, the tax implications of these strategies can drag on long-term returns, leading investors to reconsider their investment in covered-call ETFs.

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Prediction 6: ETF Fees Reverse Trend and Increase
As the ETF landscape evolves beyond cheap and index-tracking funds, the average fee of all ETFs may see a slight increase. This would mark a reversal of the trend that saw ETF fees fall since their peak in 2009. Actively managed and alternative ETFs, which typically have higher fees, are growing at a faster rate than traditional passively managed ETFs. If this trend continues, it could contribute to an overall increase in the average fee of all ETFs.

Conclusion:

While the future is uncertain, these predictions offer valuable insights into the potential trends and developments in the ETF market in 2024. The rise of active ETFs, the closure of underperforming funds, the acceleration of bond ETF launches, the growth of alternative ETFs, the potential decline of covered-call strategies, and a possible reversal in the trend of decreasing fees are all factors to consider as investors navigate the ETF landscape in the coming year. Stay informed and keep an eye on these trends as they unfold.