The municipal bond market has long been a domain for active managers, known for its complexity and inefficiency, which create opportunities to generate alpha. While ETFs have become the preferred investment vehicle for municipal bonds, a substantial 84% of municipal ETF assets remain invested in passive strategies. However, as more active investors embrace ETFs, the limitations of passive investing are becoming increasingly apparent. This paper explores the municipal market, the advantages of active management within the ETF structure and why we believe now is the time for investors to reconsider their approach.

The Muni Market Is Vast and Opportunity-Rich

The $4.2 trillion municipal market encompasses over 50,000 issuers and more than 1 million unique CUSIPs. Retail investors—including individual households and separately managed accounts (SMAs)—are the largest holders of munis, accounting for over 40% of the market. Mutual funds follow with about 20%, while banks and insurance companies hold smaller shares. ETFs represent roughly 4% of the market, but their footprint has steadily increased. As regulatory requirements have eased, banks and insurance companies have reduced their holdings, while mutual funds and ETFs have continued to grow their market shares.

Among managed assets—specifically mutual funds and ETFs—the municipal market is predominantly active, with 87% of assets in actively managed strategies. Nearly all mutual fund assets fall into this category, compared with only 21% of ETF assets. 

Municipal ETFs are rapidly gaining market share. Since the launch of the first municipal ETF in 2007, ETF assets have grown from 0% to over 16% of total fund assets. In 2025, flows into ETFs are 1.5 times greater than flows into mutual funds, and active ETFs have attracted 52% of these flows. We believe this shift highlights investors’ growing awareness of how dynamic active management can be within the ETF wrapper.

A Market That Plays Right Into an Active Manager’s Strengths

The municipal market is highly inefficient and fragmented. The Bloomberg US Municipal Bond Index, the broadest municipal index, includes more than 60,000 holdings, yet only captures 42% of the market. It leaves out a substantial portion of high yield, unrated and smaller deals—areas where active managers can hunt for opportunities.

Active managers generate alpha through rigorous credit research and strategic yield curve positioning. Their expertise enables them to underwrite complex deals and invest in lower-rated securities for higher returns while actively managing risks. Additionally, because retail investors favor short to intermediate maturities, managers can adjust their curve positioning by overweighting longer bonds when retail demand is strong and rotating to shorter maturities when demand weakens.

Other areas of opportunity for active managers are specialty state exposures, such as California and New York. Together, these two states make up nearly 35% of the index, creating concentration risk. In California, high wealth levels and a top marginal income tax rate drive strong demand for local municipal bonds, often resulting in lower yields compared to the national curve. While passive strategies must mimic these weightings, active managers can be more selective, potentially delivering higher yields to national investors.

The proof is in performance: Active funds tend to outperform passive funds in the municipal market. Over the trailing 1-, 3- and 5-year periods, active managers have outperformed the index by an average of 40 basis points annually, while passive managers have underperformed.

Seizing the Moment: Active ETFs Are Opening Doors in Munis

Growing demand for active strategies has led more managers to turn to actively managed ETFs, capturing the benefits of both worlds. The ETF structure itself offers significant advantages; for example, because most trades occur in the secondary market, inflows and outflows are absorbed without the need for cash transactions. This feature keeps trading costs low and benefits shareholders, especially during times of market stress when bid/ask spreads widen. The municipal market’s scale and complexity make it particularly well suited for active management. As flows shift and ETFs become more widely adopted for active strategies, we expect investors to increasingly recognize that active management can help them unlock greater value from this market.