How 90% of ETF assets are proactively managed

• Dina Ting
  Head of Global Index Portfolio Management
  Franklin Templeton ETF

The global market for exchange-traded funds (ETFs) has rarely been as dynamic as it is today. In the US alone, nearly 500 new ETFs were launched in the first half of 2025, with volumes exceeding half a trillion dollars. Active strategies may dominate the headlines, but index-based ETFs remain the foundation of portfolios worldwide. And yet, preconceptions persist. Many still believe that “passive” means automatic and effortless. But is replicating an index really as simple as it seems? 

In Europe, at least 220 new ETFs were launched this year, which also recorded remarkable inflows of around US$182 billion in the first six months, while Asia took in around US$40 billion with 383 launches¹ It is noteworthy that assets invested in European ETFs reached a new high of $2.74 trillion at the end of June 2025, surpassing the previous record of $2.61 trillion set in May².

Sustained growth and market momentum

The scale of ETF inflows underscores their central role in both institutional and retail investor portfolios. At the end of June, global inflows for 2025 totaled nearly $780 billion³. Within this growth in the US, approximately 63% of inflows went into index-based strategies, of which 8% went into non-market-cap-weighted approaches⁴. Actively managed ETFs accounted for around 37% of net inflows, reflecting growing demand for tactical solutions alongside core exposures⁵.

These figures show that ETFs have overcome the old distinction between “active” and “passive.” Today, the industry encompasses a broad spectrum of strategies that support both long-term allocations and more targeted, results-oriented approaches. While actively managed ETFs receive a lot of attention, index-based strategies continue to evolve and still dominate portfolio construction. Index-based strategies account for over 90% of ETF assets under management globally. Despite their importance, the portfolio management of index-based ETFs is often mistakenly described as automated or even “hands-off.” This perception obscures the discipline, precision, and constant expert oversight required for effective management.

Innovation in index-based approaches

Index-based ETFs have evolved far beyond traditional market capitalization-weighted benchmarks. They are increasingly using non-traditional and more granular data sources such as supply chain metrics, natural language models, satellite imagery, and revenue breakdowns to capture targeted investment themes.

Factor-based strategies, which have long been established in academic and practical investment discussions, are currently experiencing a renaissance. By incorporating individual or multiple factors such as quality, value, momentum, or volatility, these instruments offer investors sophisticated tools for portfolio diversification, in our opinion. In times of increased market dispersion and volatility, such approaches can provide a mechanism for precisely adjusting exposures.

Operational discipline 

A common misconception is that replicating an index requires minimal monitoring. In practice, however, maintaining alignment with a benchmark requires rigorous processes and continuous decision-making. Indices are regularly reweighted and adjusted over time to reflect changes in countries, sectors, liquidity, and corporate events. Portfolio managers must respond to mergers, acquisitions, IPOs, spin-offs, and delistings with timely adjustments to ensure tracking accuracy.

Additional complexity arises from dividend reinvestments, currency fluctuations in global markets, and different trading hours. For ETFs with hedged share classes, exchange rate risks must be managed dynamically. Cash management—whether in connection with rebalancing, subscriptions, or redemptions—requires careful execution to minimize market impact and tracking error.

Although these daily decisions are minor when viewed individually, they have a significant impact on long-term performance when taken as a whole. Effective index replication is therefore not a “passive” task, but rather the disciplined application of portfolio management expertise.

Tracking error

Tracking error, defined as the standard deviation of excess returns between an ETF and its benchmark, remains an important measure of the performance of index-based ETFs. It can arise from transaction costs, expense ratios, replication strategies, cash drag, or implementation constraints. Minimizing these deviations requires the integration of advanced trading strategies, an understanding of index methodologies, and continuous performance monitoring.  , portfolio managers use these measures to maintain the integrity of the benchmark alignment to ensure that investors achieve the results they expect from index-based ETFs.

Nevertheless, results may vary. Not all index ETFs track the index as closely as they should. That is why we believe investors need to look behind the scenes. Regardless of whether a fund is indexed or active, performance is ultimately what counts.

Advantages for investors

The structural advantages of index-based ETFs continue to appeal to investors across all segments. These vehicles offer diversification by providing exposure to hundreds or even thousands of securities through a single instrument. Their cost efficiency, supported by lower management fees, adds up over time and improves long-term results.

Transparency and potential tax advantages are other key benefits. ETFs trade on exchanges throughout the day, and holdings are disclosed daily, providing investors with a level of transparency that is not typically available with traditional mutual fund structures. In addition, intraday liquidity allows for flexible portfolio adjustments, while the breadth of available exposures enables precise targeting by country, sector, or theme. In markets such as the US, ETFs are structured to help minimize capital gains distributions, providing additional tax benefits to investors subject to these regulations.

In addition, indexed ETFs make it easier to capture market dispersion. While they offer broad market access, they also allow investors to selectively focus on countries, sectors, or themes that have favorable fundamentals or valuation characteristics.

Passive as discipline, not inactivity

Index-based investing is, in fact, an exercise in discipline, systematic monitoring, and operational rigor. Behind every indexed ETF is a team that ensures benchmarks are met, cash flows are managed, trades are executed strategically, and deviations are minimized.

As innovation in strategy development increases worldwide and its implementation progresses ever more rapidly, index-based ETFs continue to form the basis for building modern portfolios. 

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¹Source: Ibid.
²Source: ETFGI Research, July 11, 2025
³Source: Morningstar Direct, as of June 30, 2025
⁴Source: Ibid.
⁵Source: Ibid.