Investors Suddenly Have a Lot More Active Muni ETFs to Choose From

Investors can add municipal-bond funds to the list of exchange-traded funds with a rapidly growing number of actively managed choices. So far in 2024, 15 active muni-bond ETFs have been listed on exchanges, topping the previous record of 12 in 2023. That means more than 40% of the 65 active muni ETFs ever listed came to market in the last 19 months.

These new ETFs have come from big asset managers such as Capital Group, T. Rowe Price, and PGIM. The most recent entrant is Vanguard, which announced that two active muni ETFs will open later this year. “We’re not the Fred Flintstone asset class anymore,” says Scott Diamond, co-head of the municipal-bond team at Goldman Sachs Asset Management, which launched four active muni ETFs in July.

There are now more active ETFs investing in tax-exempt bonds than there are index-tracking ETFs. That’s a different picture than the landscape for ETFs. Originating as investments that mimic market indexes, passive ETFs still outnumber active ETFs by a wide margin. While index-tracking ETFs have surged in popularity thanks to their low cost, tax advantages, and long-term trends favoring indexes over active managers, the municipal-bond market has remained a bastion of active management.

Municipal bonds are a highly illiquid and fragmented market, which makes indexing difficult and creates more opportunities for active managers than more liquid markets. This favorable arena is reflected in assets; 87% of all muni fund assets are in funds where managers choose the bonds rather than mimic and index. “Munis are a category where historically investors have shown a bias towards active management,” says Jeff Johnson, head of fixed-income products at Vanguard.

As demand for ETFs grew, firms launched muni-bond ETFs. Due to the difficulty of launching active ETFs until a regulatory change in 2019, before then, there were only 19 of these funds. Between 2019 and 2024, an average of 7.5 active muni ETFs were listed each year, compared with an average of 3.5 index muni ETFs. Flows have followed, with 60% of 2024 flows to muni ETFs going to active funds despite them making up only 15% of assets.

A Fragmented, Illiquid Market

Active management dominates muni funds, partly for the same reason the space has been slow to adapt to ETFs: The muni market is highly fragmented, illiquid, and unusual.

“You may say, look I’m going to create my own index or use the complete Bloomberg index, and I think it’s going to be near impossible to buy the vast majority of those securities,” Diamond says. “A school district may issue a general obligation bond once, and it’s going to take them a long time before they need to come back to the market again, and yet your debt might have ended up in an index. How do you replicate that in a portfolio?”

The market is further complicated by the types of bonds issued. Elizabeth Foos, associate director of fixed-income strategies at Morningstar, explains: “There are general-obligation bonds, different types of revenue bonds, double-barreled securities, and all kinds of enhancement programs. On top of just a lot of issuers, it’s very fragmented in terms of securities that they offer.” This complexity means it takes the muni-bond market much longer to adapt to new investing innovations. “I would definitely put munis at the bottom of any list [of when asset classes adopt innovations],” she says.

Active Municipal-Bond ETF Listings in 2024