Large, passive funds dominate in the space.

It’s been rough sledding lately for actively managed equity mutual funds versus their passively invested competitors. Passive funds’ inflows have been growing steadily since 2011, while active funds have experienced outflows for most of that period.

Despite the headwind of investors’ shift to passive funds, actively managed ETFs have managed to keep increasing in number and assets under management, albeit from a small initial base.

According to ETF-sponsor AdvisorShares Investments’ Active ETF Report of July 31, there are about 151 active ETFs trading with combined investment assets of $26.7 billion. Apart from declines in 2010 and 2011, both numbers have shown steady growth since the funds started operating in early 2008.

Actively managed funds each have an average $177 million of assets, but here’s the statistical catch: Median assets per fund were just $26.4 million.

The median value highlights the largest funds’ category dominance: The top five funds had 50.3% of the total AUM; the 10 largest held 65.7%, according to AdvisorShares.

For example, the largest fund, PIMCO Enhanced Short Duration ETF (MINT), accounted for $4.7 billion of total AUM. Investment strategy categories are also skewed, with fixed-income funds accounting for about 70% of assets.

Growth Potential

Despite the dominance of the largest, fixed-income funds, the outlook for actively managed ETFs overall is positive, says Bethesda, Maryland-based Noah Hamman, AdvisorShares’ CEO. He cites several reasons for optimism.

As more funds meet Morningstar’s longevity requirement, the rating service reports their performance, and several funds have received 4- and 5-star ratings in their categories.

Also, when large financial services firms like PIMCO and State Street Global Advisors offer actively managed ETFs, this attracts investors’ attention to the category and validates the structure. The SPDR DoubleLine Total Return Tactical ETF (TOTL), for instance, has about $2.8 billion in assets.

Hamman points out that his firm’s funds are not competing with the passively managed and indexed ETFs, which hold about 98% of ETF assets. Instead, his target market is investors who want to combine active management in focused investment strategies with ETFs’ cost and tax advantages.

Luciano Siracusano, chief investment strategies with ETF sponsor WisdomTree in New York, is also optimistic about growth prospects for actively managed ETFs. He believes that investors remain open to using active fixed-income portfolio managers, particularly in light of the potential for U.S. rates to move higher.

Traditional fixed-income ETFs generate their applicable benchmark index return, he says, but that approach has shortcomings in a period of rising rates.

“Fixed income indexes can perform really well when interest rates are declining,” Siracusano said.

“But, if you get a period where interest rates back up and there’s some dislocation in the market because some people are selling indexed-based ETFs, that could create some pricing displacements of underlying securities. It could create an environment where active managers actually can navigate and take advantage of any mispricing that’s happening,” he explained.

A Looming Shakeout?

ETF industry sources say a fund needs a minimum AUM ranging from $25 million to $100 million to be profitable, depending on the sponsor’s operating costs and profit goals.

If the $25 million amount is accurate, about half the actively managed ETFs are on the fence. It will be interesting to see if the segment’s growth trickles down to the smaller funds; if it doesn’t, the dominance of large funds is likely to continue.