Why advisors should expect more active ETFs on the shelf this year

ETF issuers are looking for the next growth market. Canadian ETF AUM grew by over 35 per cent in 2024. ETFs picked up $141.2 billion in AUM in a single calendar year, in part driven by strong underlying asset performance, in part thanks to an ever-growing influx of investors. The trouble with a growth year so strong, however, is that it needs to be followed up. Amid changing market circumstances, the question then arises as to how ETF issuers plan to drive growth in the new year.

Bipan Rai sees that growth coming from an increasingly sophisticated and knowledgeable set of advisors and investors. The managing director, head of ETF & structured solutions strategy at BMO GAM recently authored a 2025 ETF outlook which touched on the themes that could drive or inhibit growth this year. Within a broad prediction of further growth, he noted how shifting market performance and the growing need for alpha generation could see a new influx of strategies added to the ETF product shelf this year.

“As the investor audience becomes more financially literate, that’s only going to increase the growth of the ETF sector overall in the coming years,” Rai says. “As that investor base becomes more sophisticated, we believe that there’s going to be more demand for customization and for products that allow you to stay invested during periods of increased volatility.”

While high-beta strategies like S&P 500 index ETFs are always going to be a mainstay of the ETF industry, Rai notes in his outlook that this year we may see a shift in appetite away from those index-tracking strategies because of the significant valuations now seen in certain indexes dominated by large-cap stocks. Moreover, the risk of a major correction could see investors flocking to active strategies which aim to protect against the downside.

We’ve already seen elements of that trend play out with the rise of buffer and covered call ETFs aimed at offsetting market volatility. Looking ahead, Rai says that there is potentially greater space for active management in ETFs as alpha generation becomes more of a priority. When the S&P 500 is returning 20+ per cent it is hard to generate market-beating alpha. Those returns appear less likely this year and a growing investor cohort may look at actively managed alpha generating strategies to find the gains they need.

Rai notes the example of ZLSU, the BMO Long Short US Equity ETF, which offers a more sophisticated strategy going long on attractively valued stocks and shorting stocks that the fund sees as less valuable. It’s a strategy that he says has done well since the election of Donald Trump as US President as more investors seek hedges against volatility and risk while retaining market exposure.

“It’s really during periods of expected market chop where I would suspect you’ll see some popularity rise in the liquid alternative space,” says Rai. He expects that popularity to increase this year given the macro backdrop appears less conducive to gains through high beta index strategies. Beyond liquid alternatives, too, he says that commodity ETFs may hold their appeal noting the continued popularity of Gold ETFs.

These shifts in popularity between ETF strategies need to also be taken in the context of Canada’s relatively crowded product shelf. Per dollar of AUM, Canada has around twice as many ETFs as the United States. As new products get added to the shelf, the question arises of what strategies may be shifted away to make room for them. While Rai expects that the industry will “prune” those ETFs that don’t generate enough demand, he doesn’t see a particular market segment as at risk of pruning. Rather, in a market like Canada where multiple issuers offer similar strategies there could be a winnowing of the field as certain issuers outcompete one another. In any event, its on advisors to parse through a widening and more complicated market for their clients.

“It comes down to really understanding the product and being able to communicate it in the simplest and most effective way possible,” Rai says. “Communication and understanding are absolutely critical here. If somebody were to explain a product they didn’t understand, then clients won’t be convinced or confident. You need to be able to understand an idea, express it, and tell a compelling story around it. Those fundamentals are really the most effective.”