The exchange-traded fund (ETF) structure is being used to do more as advisors increase use of active exposures, including outcome-oriented solutions. Cerulli expects the ETF structure to play a greater role in allowing access to a broader range of alternative investment exposures, including private capital product, according to The Cerulli Report—U.S. Exchange-Traded Fund Markets 2024.

Alternative investment exposures are not a newcomer to the ETF structure, but the type of exposure has meaningfully changed. In 2019, for example, commodities and real estate ETFs made up 65% of what Cerulli defines as alternative category ETFs. As of 2Q 2024, that portion is about 37%, having been pushed lower by the buildout of the derivative income, defined outcome, and cryptocurrency categories. Rapidly, the alternative investment offerings in the ETF structure have shifted from simple passive holdings to more active strategies that provide advisors with specific outcomes such as greater income and predefined return profiles.

Further change is on the horizon. Cerulli’s research finds that advisors want to increase their allocations to alternative investment products but are struggling to do so due to the drawbacks associated with the exposures. Advisor allocations to alternative investments are set to grow from a very low base, averaging about 5% when including both liquid and illiquid (approximately 2%) alternative exposures. Importantly, about half of advisors do not use alternative investments exposures due to a mix of concerns about liquidity, heightened fees, product complexity, and burdensome subscription/redemption processes on the illiquid side combined with a lack of liquid private capital product.

“While not a perfect replacement to illiquid private capital exposures, an ETF could be exactly the thing for a cohort of financial advisors looking to initiate use of true alternative investments exposures with greater operational ease,” says Daniil Shapiro, director. “That existing alternative investment allocations are so low means that even a modest exposure in an ETF moves the needle for the advisor,” he adds.

Cerulli believes that if ETF issuers identify quality liquidity and valuation processes and methodologies for offering products that offer access to private capital—likely through solutions that mix public and private exposures—they will find a meaningful market amongst financial advisors who can benefit from an intra-day liquid, easy-to-access, and tax-efficient structure. A key consideration for ETF issuers without holistic in-house private capital capabilities will be the choice of partner in an environment where scaled alternative managers benefit from the distribution reach of retail managers.

“Overall, the opportunity for advisors to access alternative investments to which they currently have low allocations in a streamlined manner is tremendous, but so are the challenges. Even well outside the private capital construct, ETF issuers should seek to ensure adequate advisor education of the drawbacks and risks to the exposures they are distributing,” he concludes.