ETFs in 2025: Roadmap to Success

Overview:

• Equity ETFs helped push the industry to experience record performance in 2024, but as it slows, investors might look to fixed income and covered call for returns in 2025.
• After the exceptional launch of Bitcoin ETFs, investors are searching for new products like private asset ETFs to repeat that success.
• Regulatory changes in Canada and the U.S. could help investors embrace ETFs, maintaining its growth momentum.

After a record year 2024, the exchange-traded fund (ETF) industry is now focused on the next leg of growth that will catapult ETFs to further records. Equity beta was the name of the game in 2024, however, equity markets have slowed in 2025 relative to last year. ETF investors therefore need to decide how to position equity investments if equity markets go sideways. Active strategies and buffer ETFs may complement a core beta position in a potentially muted market. With fixed income ETFs offering lower yields in a rate-cutting cycle, investors may also actively seek ETFs with higher yields, such as higher yielding fixed income and covered call strategies to meet their income needs.

Bitcoin made history in 2024 with IBIT becoming the most successful launch in ETF history. Currently, the ETF industry is actively searching for new products including private asset ETFs that are likely to copy Bitcoin ETF's success.

In 2025, the growth of the ETF industry may also benefit from regulatory changes. The new Life Insurance Capital Adequacy Test (LICAT) guideline in Canada is expected to increase fixed income ETF adoption among Canadian life insurers. In the U.S., the ETF industry is waiting for the regulator's decision on issuers launching ETF series of mutual funds, which could be a game changer for the U.S. ETF industry. All in all, ETFs in 2025 should continue their growth momentum with progress both in products and regulations as highlighted below.

Fixed Income ETFs – Remain Attractive Despite Lower Rates

With central banks entering rate cutting cycles, fixed income ETFs face lower yields across North America. Cash ETFs were the first ETFs to face challenges and outflowed US$1.9 billion in 2024. In 2025, investors' appetite for bonds may also diminish given lower rates. As a result, ETFs such as higher yielding fixed income ETFs and covered call bond ETFs that offer higher income may gain more traction from investors.

Higher Yielding Fixed Income ETFs – Boosting Yields

Although higher yielding fixed income ETFs (including ETFs investing in corporate high yield bonds, asset backed securities and bank loans) were one of the super stars in the U.S. ETF market in 2024, these ETFs saw muted flows in Canada. In contrast, higher yielding fixed income ETFs had total inflows in the U.S. of US$56 billion. Among these ETFs, mortgage backed securities (MBS) ETFs and collateralized loan obligations (CLO) ETFs gathered the largest inflows of US$17 billion and US$16 billion, respectively. Corporate high yield bond ETFs and bank loan ETFs also gained significant traction with US$13.5 billion and US$8.6 billion inflows. In Canada, there are only a handful of ETFs providing exposure to MBS, CLOs and bank loans. Case in point, there is still significant growth potential for higher yielding fixed income ETFs in Canada, calling for more products and better investor education.

Covered Call Bond ETFs - The New Arena for Canadian ETF Issuers

Covered call bond ETFs were one of the most successful new ETF products in Canada over the last few years. Since their inception in September 2023, these ETFs have grown from US$0.3 billion to US$1.5 billion in total assets. In 2024, these ETFs had inflows of US$1.4 billion. With falling yields for most fixed income ETFs, covered call bond ETFs have become more attractive for yield-centric investors.

Equity ETFs – Protect a Beta Portfolio

In 2024, passive equity ETFs dominated ETF flows. As the stock market gets off to a slower start, 2025 could be a very different year. As a result, investors may look for strategies to protect their equity portfolios as highlighted below.

Buffer ETFs – Taking Off in the U.S., Early Stage in Canada

Buffer ETFs might not be the most attractive investment in a bull market as they cap upside potential to a predetermined level. However, as markets face headwinds, buffer ETFs can complement or replace a core beta position by providing a buffer on the downside while keeping beta exposure. These ETFs protect against market declines and participate in the upside to a predetermined level. In the U.S., buffer ETFs are one of the fastest growing ETF strategies. In 2024, buffer ETFs in the U.S. had total inflows of US$16 billion. In addition, 120 buffer ETFs were launched in the U.S. in 2024, indicating strong demand for these ETFs. In Canada, buffer ETFs are still at an early stage. They still have room to grow in Canada, especially when the market encounters headwinds.

Covered Call Equity ETFs – The Best Time is Yet to Come

Although covered call ETFs are already popular in both Canada and the U.S., 2025 could be a record-breaking year for these ETFs. Covered call ETFs can outperform the market when the market is sideways or down, but they often underperform in bull markets. Therefore, covered call ETFs may outperform in 2025 if stock rallies stall.

Active ETFs – Strong Opportunities in 2025

Although passive ETFs saw greater fund flows than active ETFs last year due to a strong market rally, active ETFs continued to outgrow passive ETFs on a percentage basis. In 2024, active ETFs in Canada experienced total inflows of US$31.9 billion, accounting for 42% of total inflows. It is worth noting that active ETFs only account for 31% of the assets under management (AUM) of Canadian ETF market, while passive ETFs account for 69%. As a result, the growth of active ETFs significantly outpaced passive ETFs in 2024. The U.S. ETF market observed a similar trend in 2024, with active ETFs accounting for 30% of inflows and less than 10% of AUM. If markets move sideways in 2025, more investors may switch to active ETFs in seeking outperformance. Also, many active managers have added ETFs to their existing mutual fund strategies to capture the uptick in active ETFs. This in turn should attract more investors to active ETFs. With more active ETFs available on the market, active ETF adoption is likely to become more prevalent, especially among retail investors.

Private Asset ETFs – The Next ETF Boom?

Private asset ETFs have dominated the ETF headlines since a large U.S. asset manager filed for a private credit ETF in September 2024. The ETF industry is working to address challenges including the liquidity mismatch between the ETF structure and its illiquid holdings, making private asset ETFs a potentially groundbreaking addition to the market. Bitcoin ETFs set successful precedents for new asset classes to enter the ETF market. Bitcoin ETFs now hold over 5% of all bitcoin market cap one year after their inception in January 2024. If ETFs can penetrate 5% of the US$13 trillion private asset market, it will bring in US$650 billion of new assets into the U.S. ETF market.

Regulatory Changes – Potential Game Changers in Canada and the U.S.

ETF industry growth often benefits from regulatory changes. For example, the success of Bitcoin ETFs is a result of the U.S. Securities and Exchange Commission (SEC) giving green light to these products. In 2025 there are some potential game changers in the Canadian and U.S. ETF space as highlighted below.

Canadian Lifeco May Welcome ETFs to Their Portfolios

Canadian life insurers are large holders of bonds, but not of bond ETFs. Historically, holding an ETF can lead to much higher capital charges than holding the same portfolio via individual bonds. However, the new calculation method in 2025 LICAT guidance largely eliminates the punitive capital treatment for index-based fixed income ETFs, making it easier for life insurers to buy and hold ETFs.

ETF Series May Come to U.S. ETF Land

Although the ETF series of an existing mutual fund has thrived in many markets globally, including Canada, it is not widely available in the U.S. Only one issuer in the U.S. has an ETF series of mutual funds due to its previous patent on the dual class share structure. Even since the expiry of the patent, over 40 U.S. ETF issuers have filed with the SEC to apply for this structure. Many of these asset managers already have ETF lineups, but they only represent a small portion of total assets. If ETF series gets approval, it could spark a wave of ETF launches, especially active ETF launches, which are already at a record pace.