Active exchange traded funds (ETFs) surpassed the $1 trillion assets under management mark at the end of March this year, according to Bloomberg. This milestone was driven by rising market volatility and growing investor demand for professionally managed strategies that offer greater flexibility—such as income generation and downside protection—not typically found in traditional passive index ETFs. The key differences between passive and active ETFs lie in how they are managed and the strategies they aim to achieve. Passive ETFs are designed to track a specific market index—such as the S&P 500—by replicating its holdings. Since there is no active stock picking involved, the goal is simply to match the index’s performance, which typically results in lower fees for investors. Active ETFs are now being used for a variety of purposes. Beyond traditional stock picking, they also encompass strategies like factor investing—which targets securities based on attributes such as value or growth—as well as income generation and downside protection. There has been a growing shift toward Active ETFs as U.S. markets become increasingly more indexed and correlated. In recent years, what has appeared to be diversification through investing in the S&P 500 is, in reality, somewhat of an illusion. While investors do gain exposure to the 500 largest U.S. companies, there’s significant concentration risk. Larger companies disproportionately influence the index, reducing the true extent of diversification. The chart below from JPMorgan shows that, as of May 30, 2025, the top 10 U.S. companies make up nearly 40% of the S&P 500’s total value.
These so-called ‘mega caps’ have a disproportionate influence on the index’s overall performance. Essentially steering the ship for the other 490 companies. For example, let’s say Ford Motor Company’s stock were to double in value, increasing its market capitalization from $47 billion to $94 billion. The Ford Motor Company is currently ranked 213th out of the 500 largest U.S. companies by market capitalization. Market capitalization represents what investors collectively believe a company is worth at a given moment—in essence, it reflects the company’s total market value. A 100% increase in the Ford Motor Company stock would only increase the total SP 500 index by approximately 0.10%. If Nvidia— the largest company by market capitalization, valued at $3.8 Trillion as of July 3, were to double— it would increase the SP 500 index by approximately 7.4%. This means Nvidia doubling in value would have an impact on the index that is 74 time greater than that of Ford doubling. Truly staggering differences when you look at how the index works.
So far in 2025, we’ve seen 39% of ETF flows directed toward active strategies, and in May alone, a striking 94% of all new ETF launches were actively managed according to JPMorgan. The recent surge in the demand for active ETFs could be driven by the increased market concentration and heightened volatility we’re currently seeing in equity markets. This is not to suggest that the broader market has become riskier, but rather that it’s more indexed and correlated than ever before. Investors are looking for strategies that offer meaningful diversification and lower correlation to the broad index. A wide range of ETFs fall under the active management umbrella, with both equity and fixed income funds proving popular among investors with specific goals in mind. With that said, it’s still important to look under the hood of these active ETF products to understand what they’re actually holding. Some so-called active ETFs have been labeled “closeted index funds”, they claim to be actively managed but closely mirror an index while charging higher fees. Many of these funds target specific needs, but investors still seeking growth should be cautious about limiting their upside potential. Being a passive index investor early in life remains one of the most reliable strategies for building savings and accumulating assets.
For those approaching or already in retirement, it’s essential to understand how your investments perform in today’s market to ensure they align with your goals and risk tolerance. When we invest in ETFs, we’re often focused on growing our assets. But in retirement, the focus shifts. We begin withdrawing from those assets and using them as a source of income. This shift from growth to income, coincides with an increased emphasis on reducing volatility within our investments. Pre-retirees and retirees who want to avoid having their nest egg overly reliant on the performance of just a few companies should seek personalized guidance to better understand their specific situation. This is why speaking with a professional advisor is important when approaching more critical financial life events.
*Information presented is for educational purposes only and should not be construed as an investment recommendation.