Muni ETFs top 100 as demand grows

With the launch of several muni exchange-traded funds in recent weeks, there are now just over 100 muni ETFs in the space as firms ramp up their offerings to fill the gap in the marketplace and address the growing demand from clients.

"There's definitely a bit of an arms race out there," said Brendan McCarthy, global head of ETF distribution at Goldman Sachs (GS). "People continue coming to market to participate in what we think is an area that is going to continue to grow."

Muni ETFs have grown in popularity ever since the first launch in 2007, gaining a foothold due to their cost-effective nature and ability to help investors acquire a significant amount of diversification. However, some of the smaller ones may be unable to compete against the larger ones dominating the space, potentially leading to closures.

The creation of so many muni ETFs is a "meaningful" demonstration, said Pat Luby, head of municipal strategy at CreditSights.

Munis ETFs are a product designed primarily for the private client, so the creation of more muni ETFs strongly affirms how important the wealth management business is to asset managers, he said.

It also demonstrates the importance of establishing a franchise in the ETF part of the market, Luby noted.

The creation also comes from market participants' demand, said Alice Cheng, a credit analyst at Janney.

"If people are not asking, there's no demand, why would you create something?" she asked. "It takes capital, it takes effort. Why would you do it if you don't see the advantage to capture the market?"

Goldman Sachs (GS) launched four muni ETFs, all actively managed: the Goldman Sachs Ultra Short Municipal Income ETF (GUMI), the Goldman Sachs Municipal Income ETF (GMUB), the Goldman Sachs Dynamic California Municipal Income ETF and the Goldman Sachs Dynamic New York Municipal Income ETF.

This comes more than two years after the firm launched its first muni ETF: the Goldman Sachs Community Municipal Bond ETF (GMUN).

"Bringing to market the suite was very intentional," McCarthy said. "To a degree, it fills out some gaps in the broader lineup of the muni franchise, but it's allowing to have that holistic conversation that leads with exposure to muni solutions first."

The entire muni ETF universe is $125 billion in total assets. Passive ETFs are $108 million, or 86.4% of all assets, while active muni ETFs are $17 billion, or 13.6% of all assets, he said.

Passive ETFs "took off" and grew over the past four to five years, while active ETFs have been slower to adopt, McCarthy said.

"The growth of those passive [ETFs] forced the muni market to operate in a way that lends itself for further product proliferation," he said.

Now that that has happened, "the next step is we can innovate further," McCarthy said, noting the market will see more active ETFs added.

"There's definitely a bit of an arms race out there," McCarthy said. "People continue coming to market to participate in what we think is going to continue to grow."

The acceleration of the newly launched ETFs, both passive and active, also stems from money moving out of muni mutual funds and into ETFs and separately managed accounts.

Muni ETFs saw an increase in ownership in the first quarter of 2024, rising 15.7% from Q1 2023 to $122.3 billion, according to Federal Reserve data.

This includes net inflows of $528 million for the quarter, according to the Investment Company Institute.

Meanwhile, muni mutual funds were nearly flat in Q1 2022 year-over-year, ticking up 0.1% to $765.6 billion.

While the total assets for muni ETFs are just a fraction of muni mutual funds, muni ETFs are growing faster and attracting attention, Luby said.

"As assets continue to move from mutual funds into ETFs, whether it's slowly or quickly, there will be winners and losers," he said. "There are mutual fund managers who are at risk of missing the boat if they're not in ETF space."

However, not all of the muni ETFs in the marketplace may last, said Chad Farrington, co-head of municipal bond investment strategy at DWS.

The smaller funds are fighting over pieces, while the huge funds are getting bigger, he said.

And with BlackRock (BLK), Vanguard and Nuveen controlling the muni ETF market, it is going to be hard to break in, let alone make it, he said.

"I know they're in starting up mode, but there's no way you're going to get into a model. There's no way you're going to get that flow. It's going to be a slow organic growth process," he said. "And I think a lot of them are going to get five years down the road, and they'll say, 'We've gotten $25 million to $60 million, and we're making 10 basis points. So why do we have this product open?'"

Therefore, there may be closures, Farrington noted.

"Simply launching an ETF and expecting that assets will begin flowing in is a little too optimistic," Luby said.

For muni ETFs to be successful, they have to be supportive, he added.

There is a lot of infrastructure that supports muni mutual fund distribution, but that's not always the case for ETFs due to the low-cost structure, Luby said.

However, "if you're going to be new to the ETF space, you might as well just bite the bullet, swallow the expenses, and do it sooner rather than later to be supportive of the market and win some assets as money moves into ETFs," he said.