You may be surprised to learn that the first exchange-traded products came online not in the US, but in Canada. In 1990, the Toronto Stock Exchange introduced Toronto 35 Index Participation Units, widely regarded as the first exchange-traded index product and the prototype for modern ETFs. It wasn’t until three years later that the first US-listed ETF was born in the SPDR S&P 500 ETF. ETFs have since evolved from a niche idea to core portfolio toolkit, with the global market now above $21 trillion in AUM.
Where are ETFs heading? A UBS analysis published this week argues the next phase of ETF growth is unlikely to be a simple extension of the past. With the wrapper firmly established, the key question now is which use cases, asset classes and investor needs will define their future.
If Sir Isaac Newton had been an ETF investor, his law of gravity would have asserted: What goes up must come down, but will hopefully go right back up again.
After an astronomical run for semiconductors in which the memory sector fund DRAM rose almost 200% after launch, the sector is coming back down to Earth. Some 14 of the 30 companies in the PHLX Semiconductor Sector index have tumbled 20% or more amid concern that the new Chinese artificial intelligence model Kimi K3 will disrupt the AI market in the US as well as worries about the sustainability of spending in the sector more broadly. But despite the dip, investors are still pouring money into semiconductor ETFs, betting on a rebound, said James Seyffart, Bloomberg ETF analyst.
“Theoretically, you should view this as healthy,” said Seyffart. “If you look at the performance of anything, there needs to be some sort of pullback. It’s never really one straight line up.”
Chips and Dips
Chipmaker stocks had a rough weekend after Chinese AI company Moonshot unveiled Kimi K3, an open source AI model that performs comparably to OpenAI and Anthropic’s top models at a fraction of the cost. But this isn’t necessarily cause for alarm, Seyffart said. “These are the types of corrections you expect when things get really bubbly.” Semiconductor ETFs’ recent performance is “obviously not good, but it doesn’t matter because they’ve been taking in money pretty handily across the board, particularly some of the levered long exposures.”
Over the last month, the largest semiconductor ETFs have had steep losses paired with strong inflows:
The VanEck Semiconductor ETF (SMH) is down 15.3% but has had $2 billion in inflows, according to VettaFi data.
The iShares Semiconductor ETF (SOXX) slipped 18% but brought in $7.2 billion.
The Roundhill Memory ETF (DRAM) is down 30.8% but has attracted $10.7 billion in inflows.
Over in leveraged land, inflows typically pick up when products start performing poorly, said Seyffart. The Direxion Daily Semiconductor Bull 3X ETF (SOXL) is down 51% over the past month, but has brought in $2.6 billion in the same period, $1.4 billion of which was in the past five days alone. “People are trying to call a bottom and try to bet on that short-term reversal,” he said.
Banking on Memory’s Future: Semiconductor investment is predicated on the theory that memory will continue to play a major role in the AI buildout. With hyperscaler earnings coming out next week, companies will make capital expenditure projections that could affirm investors’ belief in their semiconductor bet, said David Fetherstonhaugh, an investment strategist at VistaShares. “People want to see that number increasing to get conviction that that money is going to flow proportionately to the right semiconductor companies.”
You just booked a gain on a well-timed position. The cash lands in your account, but there it stops, earning almost nothing while you wait for the next move. So you weigh the usual parking spots, but each comes with a catch:
A CD? Cash out early, and you forfeit interest.
A money market fund? Access can tighten when markets are stressed.
A short duration bond fund? Corporate debt can generate an additional tax bill.
In the words of the great fictional sports agent Jerry Maguire, ETF investors are asking funds to show them the money.
As millions of baby boomers are saying goodbye to their jobs, they’re not only demanding returns from their exchange-traded funds, but income, too. Income-oriented products, such as dividend equity and covered-call funds, have been a massive driver for inflows in recent years, and the trend shows no signs of slowing down. Funds in the derivative income category, for example, have collected $33.97 billion this year through June, according to data from Morningstar. Last year, they collected $56.1 billion. Income funds could be an interesting topic for clients and an even better way for advisors to sneak in the catchphrase: Help me, help you.
“The usage of ETFs focused on either dividend-paying equities or using options to create a different income profile is only going to increase because the needs are increasing and the scarcity is also increasing from traditional assets,” said Matt Bartolini, global head of research strategists at State Street. For example, equities are highly concentrated in high-growth sectors like technology that tend to reinvest rather than pay out dividends, while bond investors have been grappling with lower policy rates and yields.
You Had Me at Monthly Income
Income ETFs are also one of the first places investors look when they are putting money back into the market from money market funds or cash, said Todd Brighton, a senior vice president at Franklin Templeton. Plus, many investors are still skittish from the inflationary spike in 2022 and bouts of market volatility over the past few years.
“Income strategies provide a more conservative way to re-enter markets,” he said, adding that strategies that provide income may be seen as more reliable than those that provide just price appreciation.
JPMorgan has been leading the charge:
Of derivative income funds, JPMorgan Nasdaq Equity Premium Income ETF (JEPQ) has taken the most flows this year through June with $5.99 billion, but JPMorgan Equity Premium Income ETF (JEPI) remains the largest derivative income ETF with over $45 billion in assets, according to Morningstar’s data.
The NEOS Nasdaq-100 High Income ETF (QQQI) and NEOS S&P 500 High Income ETF (SPYI) follow with roughly $13 billion and $10.7 billion, respectively.
Who’s Coming With Me? Brighton says diversification is particularly important right now, since there are many asset classes that provide sources of income, and they all have their own drivers of return and risk. “Diversifying across those sources of risks and income is what can provide investors a smooth ride and consistent income experience over the market cycle,” Brighton said.
No one likes taxes. Which is why investments tailored to maximize tax relief seem to be the next big trend.
Exchange-traded funds have had a record year so far, thanks in no small part to their tax efficiency. But just how tax-savvy can these products get? Issuers are racing to find out, launching new strategies that push the boundaries of what tax shortcuts can achieve. Equity ETFs like the iShares Core S&P 500 ETF (IVV), which limit taxable gains, have taken off in recent years, and earlier this month, Kurv Investment Management launched its US Large Cap TaxOptimized ETF (LCTO), which tracks the S&P 500 while trying to boost after-tax income. Another reason behind the push for tax-friendly products may be a series of Securities and Exchange Commission decisions stemming back to the ETF Rule.
“In 2019, the SEC made a rule change that allowed for these more sophisticated strategies to be in an ETF format,” said Howard Chan, chief executive of Kurv. “A second rule change allowed for some deferral of taxes of various instruments in the portfolio. So it’s sort of like the perfect storm.”
Tax Me If You Can
ETFs are more tax-efficient than their mutual fund counterparts for a few key reasons. One is their relatively low turnover, which matters because when fewer stocks are sold, there are lower capital gains taxes, meaning investors can rest assured that their products are likely to only incur those taxes when they sell. Most strategies passively track indexes, which don’t trade as often as active products, although the latter are gaining ground quickly. But there’s a limit on what standard index funds tracking things like the S&P 500 can return, meaning the next logical avenue for yield growth is in structuring the products differently so as to minimize taxes, Chan said.
There are a few different types of tax-efficient strategies available to investors:
One is the “traditional kind,” Chan said, such as tax-advantaged assets in the form of municipal bonds.
Another is option income strategies, which generate distributions that often have a lower tax rate than ordinary income.
A third is funds that use tax loss harvesting mechanics such as the 130-30 strategy, which entails allocating 130% of a product’s capital to long positions while shorting 30% of its underperforming stocks.
“You’ve seen the outgrowth of [tax-loss harvesting] that has been extremely popular for the last two years,” Chan said. “All of these combined shows momentum.”
The 351 of It All: So-called 351 exchanges are symptomatic of the tax-advantaged frenzy, Chan said, since many people have held fast-growing stocks like Microsoft and Google for many years, but these companies’ large capital gains can hinder returns.
“We get this feedback from advisors … that they can’t really move any of these positions because if they were to sell out of it, they would have to pay a huge amount of tax liabilities,” he said. “What we [will] see in the second half is that obviously as the technology sector continues to do well, that hidden tax liability just continues to grow.”
We Got the Flows: Investors added more than $46 billion to US-listed ETFs last week, including more than $25 billion flowing into US equity ETFs. That puts total inflows at more than $1.15 trillion so far in 2026.
Room to Run: Despite institutional investors’ broad use of ETFs, actual allocations remain relatively low, with only a third of North American institutions allocating more than 10% of portfolio assets to ETFs.
In-House ETFs: For advisors and asset managers watching the breakneck pace of active ETF launches, the question for some registered investment advisors has shifted from whether to launch their own ETF to how.
ETF Upside is a publication of The Daily Upside. For any questions or comments, feel free to contact us at etf@thedailyupside.com.
Disclaimers
*An investor should consider the investment objectives, risks, charges, and expenses carefully before investing. To obtain a fund’s Prospectus, which contains this and other information, contact your financial professional or call 888.622.1813. Read the Prospectus carefully before investing.
Exchange Traded Funds (ETFs) are considered to have continuous liquidity because they allow for an individual to trade throughout the day, which may indicate higher transaction costs and result in higher taxes when fund shares are held in a taxable account.
The funds are non-diversified and can invest a greater portion of assets in securities of individual issuers, particularly those in the natural resources and/or precious metals industry, which may experience greater price volatility. Relative to other sectors, natural resources and precious metals investments have higher headline risk and are more sensitive to changes in economic data, political or regulatory events, and underlying commodity price fluctuations. Risks related to extraction, storage and liquidity should also be considered.
Shares are not individually redeemable. Investors buy and sell shares of the funds on a secondary market. Only “authorized participants” may trade directly with the funds, typically in blocks of 10,000 shares.
The Sprott Rare Earths Ex-China ETF and the Sprott Active Metals & Miners ETF are new and have limited operating history.
Sprott Asset Management USA, Inc. is the Investment Adviser to the Sprott Copper Miners ETF. ALPS Distributors, Inc. is the Distributor for the Sprott ETFs and is a registered broker-dealer and FINRA Member. ALPS Distributors, Inc. is not affiliated with Sprott Asset Management USA, Inc.
**The term “pure-play” relates directly to the exposure that the Fund has to the total universe of investable, publicly listed securities in the investment strategy.
***TRSY: All investments involve risk, including loss of principal. Information on the fund’s investment objectives, risk factors, charges, and expenses can be found in the fund’s prospectus at Xtrackers.com. Read it carefully before investing.
The fund is not a money market fund and is not subject to the strict rules that govern the quality, maturity, liquidity and other features of securities that money market funds may purchase. Under normal circumstances, the fund’s investments may be more susceptible than a money market fund’s investments to credit risk, interest rate risk, valuation risk and other risks relevant to the fund’s investments. US Treasury obligations are backed by the “full faith and credit” of the US government. The “full faith and credit” guarantee of the US government applies to the timely repayment of interest, and does not eliminate market risk. Because of the rising US government debt burden, it is possible that the US government may not be able to meet its financial obligations or that securities issued by the US government may experience credit downgrades.
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