The race to define active ETFs is wide open

Almost every active ETF on the market today is, in a sense, roughly the same age. After years on the indexing side of the industry, Brandon Clark saw something unusual in active ETFs: few entrenched positions and plenty still to be built.

“We all started from scratch around 2020, with the passage of the ETF rule,” said Clark, Director of ETF Business at Federated Hermes. Mutual funds carry a century of track record behind their leaderboard; active ETFs do not. “There’s no predetermined position on where anybody lives in that leaderboard,” he said.

That open field is what drew Clark to Federated Hermes nearly six years ago, and why he sees the roughly $12 trillion still in actively managed mutual funds (as of 6/30/26 per Investment Company Institute) as available territory for the ETF wrapper. What advisors are asking that wrapper to do, however, has become more specific.

Income has changed shape, not disappeared

Income is one place where the appeal of a more targeted approach is becoming clearer. Rate uncertainty has kept some advisors focused on the front end of the curve, where Clark sees an attractive trade-off between the yield available and the duration risk required to earn it.

“Clients are trying to manage duration, not knowing the path of travel for rates,” he said. “Can I lock in those yields without going all the way out and introducing that volatility again?”

That matters because extending farther out no longer necessarily buys an advisor substantially more income. Clark’s point is that much of the available yield potential may still be captured at the short end, allowing advisors to potentially limit interest-rate sensitivity rather than taking additional duration risk for a relatively modest pickup in yield.

Federated Hermes has built several strategies around that trade-off. Federated Hermes Ultrashort Bond ETF (FUSD) targets duration of one year or less, giving advisors a way to move beyond money markets while remaining close to the front of the curve.

The same principle applies in high yield. Short Duration High Yield ETF (FHYS) seeks to capture competitive yield with lower duration than the overall high-yield market.

That is what can make the short end more than a temporary parking place. For advisors, it can be used to fine-tune a core fixed-income allocation while preserving flexibility if the rate outlook changes. Clark said covered-call strategies have continued to attract interest since 2022 as advisors rethink how clients can generate cash flow without giving up equity exposure altogether.

“The question becomes, what’s my equity risk mix look like?” he said. “I might be able to actually keep some equity risk on the table using some of these covered-call strategies.”

That broadens the income decision considerably. Advisors can now choose among short-duration bonds, longer duration credit and options-enhanced equities, each with a different mix of duration, volatility and market exposure.

Concentration risk is prompting real portfolio changes, not just conversation

Concentration in a handful of mega-cap names is no longer only a talking point for advisors, according to Clark. It is showing up in how they build portfolios. “Advisors worry when five to ten stocks are driving outcomes,” he said, “so they’re thinking about how to best manage that risk.”

Clark does not see concentration as a new phenomenon. Market-cap-weighted indexes have always allowed successful companies to become larger positions. What has changed is the degree to which advisors are considering whether that concentration still suits the role an allocation is meant to play.

Based on his conversations with advisors, Clark seeks some advisors responding by leaning into equity exposures built on a different set of rules, tilting toward dividend-paying, lower-volatility names and increasing allocations to companies with durable fundamentals as market winners have extended their gains.

Federated Hermes’ equity income ETF lineup is built around that same tilt. Federated Hermes US Dividend ETF (FDV), a U.S. dividend strategy, and Federated Hermes Enhanced Income ETF (PAYR), which has an option overlay on that dividend franchise, both give advisors defensive equity exposure without the same reliance on a small number of names driving returns.

The wrapper matters too

Implementation can change the result as much as the exposure itself. “The wrapper makes a huge difference,” Clark said. His analysis showed that active ETFs exhibited an average annual tax burden 1.26% lower than active mutual funds for the 5-year period ending 4/30/26, and 1.48% lower for the 3-year period ending 4/30/26.¹ Asset location across taxable and tax-deferred accounts can further affect returns.

Daily trading volume can also be misleading. A lightly traded ETF is not necessarily illiquid, since the underlying securities and the creation and redemption process also determine how easily it can trade.

As the active ETF market fills out, Clark expects advisors to become more selective, not less. He believes “more advisors are going to look for alternative ways to get exposures other than just through index-tracking funds,” he said.

^{1 Source: Morningstar, Inc., as of April 30, 2026. The analysis covers 2,518 U.S. equity mutual funds and ETFs across nine Morningstar categories. “Tax burden” (tax drag) is defined as the difference between total return and Morningstar’s pre-liquidation after-tax return, which reflects taxes paid on income and capital gain distributions but excludes taxes that would be incurred upon liquidation of fund shares. Results represent averages of fund-level tax drag for the specified periods. Comparisons are based on actively managed ETFs versus actively managed open-end mutual funds. All returns are net of expenses and calculated using Morningstar’s standardized methodology, which assumes the highest applicable US federal marginal tax rates and reinvestment of after-tax distributions. The analysis does not account for state or local taxes, investor-specific tax circumstances, transaction timing, or holding period differences, and actual investor outcomes may vary.}

^{Please carefully consider the funds’ investment objectives, risks, charges and expenses before investing. For this and other information, call 1-800-341-7400 or visit FederatedHermes.com for a summary prospectus, or prospectus. Read it carefully before you invest.}

^{Federated Securities Corp., Distributor}

^{Past performance is no guarantee of future results.}

^{The yield curve compares yields according to maturity.}

^{Duration is a measure of a security’s price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations.}

^{Investing in options involves risks different from, or possibly greater than investing in traditional investments.}

^{Stocks may decline in value because of an increase in interest rates or changes in the market.}

^{There are no guarantees that dividend-paying stocks will continue to pay dividends and they may not have the same capital appreciation potential as other stocks.}

^{Federated Hermes Enhanced Income Fund (PAYR) seeks to distribute current monthly income. Distributions may vary widely and may not be paid every month.}

^{FUSD is not a “money market” mutual fund. Some money market mutual funds attempt to maintain a stable net asset value through compliance with relevant Securities and Exchange Commission (SEC) rules. The fund is not governed by those rules, and its shares will fluctuate in value.}

^{Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. In addition, fixed-income investors should be aware of other risks such as credit risk, inflation risk, call risk and liquidity risk.}

^{An investment in an exchange-traded fund (“ETF”) generally presents the same primary risks as an investment in a fund that is not exchange traded and may also be subject to other risks, such as: (i) ETF shares may trade above or below their net asset value; (ii) an active trading market for an ETF’s shares may not develop or be maintained and (iii) trading of an ETF’s shares may be halted by the listing exchange’s officials. ETFs can be tax-efficient because of their unique structure, which involves using an in-kind trading process, meaning that managers trade securities in “units,” also known as blocks or baskets of securities, which are exempt from capital gains due to a tax law that rules that funds can avoid triggering a tax event by trading in-kind, rather than in cash. When investors sell shares, which could normally trigger a tax event (such as capital gains tax on profits), investors either trade the ETF in-kind to one another on the secondary market or ETF managers redeem the shares by transacting in units, with the help of APs. If these transactions are in-kind rather than cash, which they typically are, no tax event is triggered.}

^{ETFs and mutual funds are subject to risks and fluctuate in value. Note that ETFs are not immune to capital gains and many equity ETFs do pay dividends on which taxes are owed.}

^{High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risks and may be more volatile than investment grade securities.}

^{Views are as of 8/17/26 and subject to change. This material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations.}