Exchange-traded funds (ETFs), which were first launched in the U.S. in the 1990s and were mainly concentrated on tracking stock indices such as the S&P 500. Offering an attractive combination of decreased cost, increased tax efficiency, and greater convenience over many other traditional investment options, ETFs have proliferated and are now available across fixed income, commodities, and even cryptocurrency. As of June 30, 2024, investors held approximately USD 8.7 trillion in ETF assets spread across three distinct categories:

Passive

Passive ETFs typically track a market‑capitalization-weighted index that seeks to duplicate the returns of a stated benchmark, less fees and expenses. These ETFs provide exposure to a particular market or segment of a market. Depending on the benchmark, they may provide diversification in a single holding. For example, an S&P 500 Index ETF would provide broad diversification across equities. On the other hand, a financials sector ETF could seek diversification specifically within the financials sector but would not offer broad market diversification.

Smart beta/factor

Smart beta or factor ETFs use rules‑based indexes to gain exposure to certain factors, such as low volatility or momentum. Typically, these are single-factor ETFs, and, as a result, the diversification and performance of these ETFs may vary considerably as the specific factor’s performance impacts results. For example, a low-volatility ETF may have fewer diversification benefits than a market cap ETF as all holdings share the same low volatility factor. These strategies may underperform for a time if the market favors another factor—quality, for example. Finally, factor ETFs are typically more expensive than passive ETFs.

Active

More recently, active ETFs have entered the marketplace. Active ETFs employ a portfolio manager who makes buy and sell decisions, actively constructing a portfolio in pursuit of benchmark outperformance. This outperformance could be based on performance or another metric, such as lower risk or better risk-adjusted returns. Fees are typically higher than passive ETFs but tend to remain attractive versus other investment vehicles.

Active ETFs show the fastest growth in a changing ETF landscape

Looking at net asset growth rates in Figure 1, active ETFs grew at an impressive 155% from July 2021 through June 2024, followed by smart beta/factor ETFs (38%). Passive ETFs grew at a slower pace over the period (25%), although this slower growth rate was from a much larger asset base. Figure 2 shows the change in ETF assets by type over the same time period, suggesting that active ETFs took share from passive ETFs rather than from smart beta/factor.

More investment advisors are embracing active ETFs

In Figure 3, we looked at models in our proprietary client database of investment advisors. From June 2021 through June 2024, the chance of active ETFs being used grew from 15% to 36%, and smart beta/factor ETFs increased from 44% to 57%. Over the same period, the use of passive ETFs also grew, but at a lesser rate.

Figure 4 shows the average allocation in these same models over the period. Allocations to active ETFs increased over the period alongside smart beta and passive.

How to redeploy cash in today’s market using T. Rowe Price active ETFs

Fixed income

With all eyes on central bank policies, investors are looking to lock in higher rates while adding credit and duration. Investors looking to redeploy cash into fixed income could consider the following:

Ease into the market with the Ultra Short‑Term Bond ETF (TBUX).

• For increased duration, redeploy cash to the QM U.S. Bond ETF (TAGG) for U.S. aggregate index-level duration and active management.
• Add both duration and credit with the Total Return ETF (TOTR).
• Take advantage of higher yields via the Floating Rate ETF (TFLR) or U.S. High Yield ETF (THYF).

Equity

As U.S. stocks face a broadening of performance rather than a rotation, consider the following options:

• Fewer interest rate cuts may favor value stocks such as the Equity Income ETF¹ (TEQI) or Value ETF (TVAL).
• With small-caps trading at a major discount to larger companies, consider the Small-Mid Cap ETF (TMSL).
• Diversify away from Magnificent 7 stocks:
  • The Capital Appreciation Equity ETF (TCAF) allocates to a contrarian investment manager focused on finding good companies while mitigating long-term secular risks.
  • The U.S. Equity Research ETF¹ (TSPA) employs an actively managed, high-alpha portfolio run by over 30 analysts with mandatory benchmark sector exposure resulting in less concentration risk.
  • Embrace active management where valuations are higher with the Blue Chip Growth ETF¹ (TCHP) or Growth Stock ETF¹ (TGRW).
• Seek to improve your portfolio’s relative downside by adding to dividend growth stocks with the Dividend Growth ETF¹ (TDVG).
• And with international stocks still offering good value relative to U.S. equities, consider the International Equity ETF (TOUS).

T. Rowe Price Portfolio Construction Solutions can help

If you’re preparing to redeploy cash into the market and are considering ETFs as an option in your model, we can help. Supported by the multi-asset experience and global resources of T. Rowe Price, our integrated suite of Portfolio Construction Solutions is designed to address your portfolio construction needs and help position your practice for success.