ETF Market Sees Surge in Active Funds Amid Regulatory Scrutiny

ETF Market Sees Surge in Active Funds Amid Regulatory Scrutiny

The exchange-traded fund (ETF) market is witnessing significant developments, particularly in the realm of actively managed funds. This surge comes amid increasing regulatory scrutiny and evolving investor preferences.

Rise of Active ETFs

Active ETFs, which combine the benefits of traditional ETFs with active management strategies, have gained traction. Capital Group, the world’s largest active asset manager, recently introduced eight model portfolios composed entirely of its own active ETFs. This move aligns with the growing trend of financial advisers favoring pre-constructed model portfolios to streamline investment processes. These portfolios cater to specific risk levels or investment goals and have become increasingly popular in the U.S. market. Capital Group’s new offerings leverage their 22 ETFs, which have amassed $53 billion in assets. By utilizing ETFs, advisers benefit from lower fees and increased tax efficiency compared to mutual funds. The model portfolio market, valued at $2 trillion in the U.S., is traditionally dominated by broker-dealers but is seeing a shift towards asset manager and third-party operated portfolios. The launch of Capital’s all-active ETF portfolios is seen as a response to the evolving financial advice ecosystem, where advisers focus more on comprehensive financial planning and outsource investment management. Additionally, many U.S. asset managers plan to introduce actively managed ETFs in the near future, further enhancing the availability of model portfolios. Source

Regulatory Concerns Over ‘Shy Active’ Practices

Despite the growth, the active ETF sector faces challenges. A significant number of investment managers are under scrutiny for promoting ETFs as actively managed while closely mirroring benchmark indices, a practice termed “shy active” by Morningstar. A survey by Carne Group revealed that 88% of wealth managers and institutional investors believe these ETFs fail to meet their active management claims. Transparency concerns, especially due to European regulations mandating daily portfolio disclosures, have impeded the launch of genuinely active ETFs, as managers fear revealing proprietary trades. However, new semi-transparent structures introduced in Luxembourg and Ireland are expected to encourage truly active fund strategies by protecting trade confidentiality. Experts emphasize the importance of transparency and investor awareness about what such ETFs truly offer. Despite claims of misleading practices, some argue for the utility of low tracking error funds, provided their strategies and performance metrics are clearly disclosed. The active ETF market remains nascent in Europe, but anticipated regulatory changes may lead to more authentic offerings in the near future. Source

Investor Savings and Market Growth

U.S. investors have saved $250 billion by investing in ETFs instead of traditional mutual funds since 1993, according to Bank of America. These savings, equivalent to 2.5% of the $10 trillion U.S.-listed ETF market, come primarily from tax advantages rather than just lower fees. The average expense ratio for U.S. ETFs is 0.16% compared to 0.44% for mutual funds, but the significant tax savings are what truly benefit ETF investors. ETFs incur lower “tax drag” due to their structure, minimizing capital gains liabilities. Unlike mutual funds that need to sell underlying assets to handle redemptions—incurring capital gains taxes—ETFs can transfer stock “in-kind” to market makers, avoiding such taxes. Consequently, while ETF investors may pay somewhat higher taxes upon selling their holdings, these tend to be long-term gains taxed at lower rates. The ongoing shift from mutual funds to ETFs has seen investors withdrawing over $2 trillion from mutual funds and investing a similar amount in ETFs over the past decade, enhancing future cost savings for investors. Source

Global Developments

In Europe, major global asset managers such as BlackRock and BNP Paribas have launched new ETFs focused on the continent’s defense industry. These funds aim to capitalize on increased defense spending by European governments, spurred in part by calls for Europe to become less reliant on American military support. Over the past seven months, at least nine Europe-focused defense ETFs have been introduced, a recent trend in a market that already offers more than 50 defense ETFs globally. So far in 2025, investors have injected $8.4 billion into defense ETFs, with $2.7 billion directed toward the European-focused variants, more than double the total investment for all of 2024. BlackRock’s new ETF was listed in Amsterdam and Frankfurt, while BNP Paribas’ ETF is already listed in Paris and will soon be listed elsewhere in Europe. These funds typically include companies within European NATO member states. The surge in defense stock values has encouraged more money managers to enter this space, including firms like Allianz and UBS, which have relaxed previous restrictions on defense investments. Source

Meanwhile, China is considering granting access to Western firms like Citadel Securities and Jane Street to operate as market makers in its $520 billion ETF market. This move could enhance trading efficiency and reduce costs due to the experience international firms bring in providing ETF liquidity. Over the past two years, China has expanded its ETF sector significantly, growing 134% to become Asia Pacific’s second-largest behind Japan. Despite the growth, ongoing U.S.-China trade tensions, including recent U.S. tariffs of 145% on Chinese goods, may delay approval for U.S. firms. Market makers offer continuous buying and selling prices for ETF shares, enabling smooth trading, and licensed market makers in China benefit from reduced fees and trading restrictions. Citadel has already applied to establish a brokerage unit in China, though none of the firms or China’s securities regulator has publicly commented. While China has opened more of its financial sector to foreign firms in recent years, geopolitical tensions and economic slowdown have led firms like Fidelity, Morgan Stanley, and Legal & General to scale back their operations in the country. Source

Market Performance

As of May 31, 2025, major ETFs have shown the following performance:

• SPDR S&P 500 ETF Trust (SPY): $589.39, down 0.078% from the previous close.
• Vanguard S&P 500 ETF (VOO): $541.76, down 0.046% from the previous close.
• Invesco QQQ Trust Series 1 (QQQ): $519.11, down 0.112% from the previous close.
• iShares Russell 2000 ETF (IWM): $205.07, down 0.495% from the previous close.
• iShares MSCI Emerging Markets ETF (EEM): $45.52, down 1.27% from the previous close.

These figures reflect the dynamic nature of the ETF market, influenced by various economic and geopolitical factors.

In conclusion, the ETF market is experiencing a surge in active funds, facing regulatory scrutiny over ‘shy active’ practices and transparency concerns. Investors are benefiting from cost savings and tax efficiencies, while global developments continue to shape the landscape of ETF investments.