EFTs Continue to Surge: What Investors Need to Know

Exchange-traded funds (ETFs) are expected to continue their surge. Statistics reveal that, so far in 2025, ETFs have attracted over $1.54 trillion in global inflows, pushing total global ETF assets under management to over $18.81 trillion. ETFs were first introduced in 1993, and they have always been viewed as the little sister to the mutual fund industry, living in the shadow of their older, bigger sibling. ETFs may still be dwarfed by the number of mutual funds and their assets under management (AUM), but ETFs have closed the gap over the past decade and continue to gain popularity. The number of mutual fund-to-ETF conversations has increased significantly in recent years, with 2025 already surpassing 2024’s record number of conversations.  

Key Takeaways 

• ETFs continue to gain traction, with 2025 seeing significant global inflows and closing the gap with mutual funds. 
• Key features of ETFs include intraday trading, tax efficiency through authorized participants, and lower expense ratios. 
• The adoption of the SEC's "ETF Rule" in 2019 has expedited the launch process for ETFs, contributing to a surge in ETF offerings, while non-transparent and semi-transparent ETFs remain a niche segment. 

What Are ETFs? 

Similar to mutual funds, ETFs are pooled investment vehicles that invest primarily in liquid securities. ETFs are organized as open-end management investment companies registered with and regulated by the SEC under the Investment Company Act of 1940 (40 Act). Under the 40 Act, both mutual funds and ETFs are subject to the same requirements, such as: 

• Leverage limitations 
• Daily valuation 
• Liquidity requirements 
• Prohibitions on affiliate transactions 
• Having their advisor be a registered investment advisor (RIA) 

Both vehicles also typically elect to be treated as Regulated Investment Companies (RICs) for tax purposes under Subchapter M of the Internal Revenue Code. 

What Are the Differences Between Mutual Funds and ETFs? 

There are several key differences between mutual funds and ETFs.  

Retail Investors  

The key area where mutual funds and ETFs differ is how shares of the funds are transacted with retail investors. Mutual fund shares are bought and sold at the net asset value (NAV) per share computed at the end of a trading day through a variety of different distribution channels or directly with the fund. ETF shares are listed on national security exchanges and trade throughout the day at the market price rather than ETF’s NAV. Retail investors would buy and sell shares of an ETF through a broker-dealer in the same fashion they would purchase or sell any other stock. 

Authorized Participants  

A unique feature of an ETF is the use of authorized participants (APs). An AP must be a licensed broker-dealer and can clear securities with the Depository Trust & Clearing Corporation (DTCC). Typically, large financial institutions fill this role and enter into agreements with the ETFs to act as APs. Only APs can purchase blocks of shares (normally 25,000 at a minimum) known as “creation units” directly from an ETF. APs typically deliver a basket of securities similar to those held by the ETF in exchange for shares of the ETF. When an AP redeems shares from an ETF, the ETF delivers a basket of securities to the AP in exchange for the ETF shares. Cash purchases and redemptions are possible, but in-kind exchanges are preferable, as they help the ETF avoid the costs of executing buys or sells of the underlying securities, and provide the tax advantages described below. The DTCC helps deliver the promised transaction shares to the ETF and the AP. 

Tax Efficiency Through APs 

This distinctive feature makes ETFs highly tax-efficient for their shareholders. In general, corporations making distributions of appreciated property are required to recognize gains as if such property were sold. However, ETFs electing to be taxed as RICs are exempt from recognizing any unrealized gains on securities redeemed in-kind per IRC Sec. 852(b)(6). Since ETFs can offer tax-free in-kind redemptions versus recognizing gains upon the sale of appreciated securities, the ETF limits the amount of taxable capital gain distributions passed through to its shareholders. 

Investor Flexibility  

Having the ETF shares available on a national exchange gives investors the flexibility to trade shares intraday at market value. It also allows smaller investors to purchase smaller quantities of ETFs, unlike some mutual funds, which have minimum investment amounts. Initially, the portfolio turnover on index-based funds was relatively low, resulting in lower trading costs for the ETFs. However, in recent years, the increase in actively managed ETFs, in which the advisor has discretion over trading based on the fund’s investment objective, has been similar to that of mutual funds. In fact, as of May 2025, there were 3,671 actively managed ETFs listed globally, a significant increase from 207 in 2020.  

The ETF Rule 

One hindrance that ETFs faced for years was the requirement that each ETF obtain SEC exemptive relief from certain provisions of the 40 Act before launching. In September 2019, the SEC adopted the “ETF Rule” (Rule 6c-11 under the 40 Act), which allows ETFs that meet certain conditions (e.g., daily disclosure of portfolio holdings, disclosure on its website regarding premium, discount and bid-ask spread information, as well as written policies and procedures regarding basket construction and the process of accepting baskets) to begin operations without first obtaining the specific 40 Act exemptive relief previously required. The adoption of the ETF Rule facilitates ETF sponsors in getting their products to market much more quickly, without the added expense of filing for exemptive relief from the SEC. The adoption of Rule 6c-11 is undoubtedly a driving factor in the continuous surge in ETFs. 

Non-Transparent and Semi-Transparent ETFs 

Beginning in 2019, the SEC granted exemptive relief to certain ETF sponsors seeking to launch ETFs that report their portfolio holdings only on a quarterly or monthly basis, rather than daily. These are known as non-transparent and semi-transparent ETFs. Because their portfolio holdings are less transparent, they cannot take advantage of the “ETF Rule.” It remains to be seen how many ETF sponsors will incur the additional cost and wait time or if there is a substantial market for less transparent funds. 

What Does the Future Hold?

A comparison of the net cash flows between ETFs and mutual funds over the last several years indicates that ETFs are currently the vehicles of choice for most investors in non-retirement accounts. This is most likely due to a combination of the key factors discussed earlier, lower expense ratios, intra-day trading availability, and lower tax exposure. To learn more about ETFs or how you can leverage ETF investments, contact us below.