ETF Slop: Why Most New ETFs Are Built to Sell, Not Perform

The ETF Market Has a Quality Problem

For the first time in US market history, there are more ETFs than individual stocks. Over 1,000 new ETFs launched in a single year in the US alone, with more than 300 hitting Canadian markets in the same period. The majority of those launches were actively managed. The average management fee for US-listed ETFs launched recently exceeds 0.7%, and 166 of the new funds carry fees above 1%.

This is not the ETF revolution that democratised investing. This is something else — a flood of complex, high-fee products engineered primarily to attract assets rather than improve outcomes. Call it ETF slop: a high-volume proliferation of investment products that look innovative on paper but are likely to leave most buyers worse off.

The original promise of ETFs was straightforward: get broad market exposure at a fraction of the cost of actively managed mutual funds. Index ETFs with fees below 0.1% made that promise real. Investors responded by pulling billions from high-fee active funds. That was a genuine win. But the fund industry, facing squeezed margins and entrenched competition from giants like Vanguard and BlackRock, didn't sit still. Instead, it pivoted — packaging complexity, leverage, and behavioral appeal into ETF wrappers and marketing them aggressively to retail investors.

The result is a market where finding quality is harder than it used to be. The good products still exist. They're just increasingly buried.

Thematic ETFs: Buying the Story After the Peak

Thematic ETFs focus on specific economic trends — AI, clean energy, electric vehicles, cannabis, the metaverse. They are among the most emotionally compelling products in the ETF market, and among the worst-performing.

The mechanism behind their underperformance is well-documented. Thematic ETFs typically launch after the theme they represent has already delivered strong returns and attracted heavy media coverage. By the time the fund is available to retail investors, the stocks it holds have already been bid up to reflect optimistic expectations. What follows is predictable: expectations normalise, prices fall, and performance disappoints.

A 2021 academic study found that thematic ETFs underperform by an average of 6% per year in the five years following launch. Morningstar's Global Thematic Fund Landscape report reinforces this, finding that just over 10% of thematic funds globally manage to both survive and outperform global equities at the 10-year horizon. For Canadian-listed thematic funds, the data is more severe — 100% either close or underperform at 10 years, and 100% close by the 15-year mark.

Canadian cannabis funds illustrate the pattern in extreme form. When Canada legalised cannabis, thematic funds built around that sector peaked at more than 60% of the entire Canadian thematic fund market. They now account for roughly 1.4%. Today's hot themes — AI and cybersecurity — may not replicate that exact trajectory, but the structural dynamics driving thematic underperformance haven't changed.

Three investor biases drive persistent demand for these products despite the data:

• Attentional bias: investors are drawn to whatever is generating headlines
• Optimism bias: they overestimate the likelihood of a strong outcome
• Extrapolation bias: they assume recent performance will continue indefinitely

Fund companies know which themes trigger these biases. Launching around them is profitable for issuers. For investors, the long-term data suggests it rarely is.

Buffer ETFs: Paying a Premium for False Security

If thematic ETFs exploit investor optimism, buffer ETFs exploit the opposite — loss aversion and pessimism. These funds are structured to offer market exposure with a defined downside buffer, typically absorbing the first 10–15% of losses, in exchange for a cap on upside returns.

The engineering is genuinely clever. A fund might offer exposure to a US large-cap index, capped at 8.1% upside over a defined period, with protection against the first 15% of downside. For investors who need that exact payoff profile, it does what it says.

The problem is the cost and the fine print. A 2025 paper titled Rebuffed: An Empirical Review of Buffer Funds examined all US-listed defined outcome funds in the Morningstar database with at least 24 months of history. Key findings:

• The majority of buffer funds deliver inconsistent downside protection, with realized losses frequently exceeding what marketing materials imply — particularly outside narrowly defined target outcome periods
• Management fees for buffer funds are substantially higher than the underlying index exposure they reference (one major provider charges 0.73% for the buffer version versus 0.09% for a straightforward equity ETF)
• Simple alternatives — mixing equities with cash — generally outperform buffer funds on average, including during drawdowns

That last point is critical. The protection investors think they're buying can often be replicated more cheaply and more effectively by just holding less equity. An investor who finds a fully-invested equity portfolio too volatile doesn't need a complex options-based product. They need a more appropriate asset allocation, expressed through low-cost index funds.

The authors of Rebuffed conclude that much of the innovation in this space is "superficial and engineered more for sales than for substance." The behavioral appeal is real — few investors will turn down the idea of shock absorbers in their portfolio. But the cost of those shock absorbers, and their actual performance in real market conditions, rarely justifies the price.

Covered Call ETFs: High Yield, Hidden Cost

Covered call ETFs have built a loyal following, in part because they are marketed with language — "yield maximizer," "high income shares," "income ETF" — that directly appeals to investors who mentally separate income from capital growth.

The mechanics: the fund holds equities and simultaneously sells call options on those holdings. The option premiums generate income, which is distributed as yield. The catch is that selling those options caps the upside. If the underlying stocks rise strongly, the fund doesn't fully participate.

This is not a free lunch. It is a trade: high current income in exchange for lower long-term total returns. The data consistently supports this view. Covered call strategies mechanically trail the total returns of their underlying equities in rising markets, which — over long horizons — describes most markets most of the time.

For investors who need income from their portfolios, the case for covered call ETFs weakens further. Analysis comparing covered call funds against a simple strategy of collecting standard dividends from an index fund and selling a small percentage of holdings to fund spending needs shows that the straightforward approach tends to produce better outcomes. No complex structure required.

Covered calls also share a characteristic with buffer ETFs: a simple portfolio of stocks and cash can closely approximate the return profile of a covered call fund without the hard cap on upside. That's a meaningful insight. When a cheap, simple combination of assets replicates an expensive complex product, the complex product is hard to justify on rational grounds — however appealing it looks in a marketing deck.

Single Stock ETFs: Maximum Complexity, Maximum Risk

Single stock ETFs represent perhaps the most concentrated form of ETF slop. They account for 27% of new US ETF launches in recent periods. They are complex. They are expensive. And they are being marketed to retail investors with names that obscure what they actually do.

Two main structures dominate:

1. Leveraged single stock ETFs — offer 2x or -1x daily exposure to an individual stock
2. Single stock covered call ETFs — generate income by selling options on individual stocks
3. Combined structures — add 25% leverage to a covered call position on a single stock

Each layer of complexity adds cost and risk. A 2025 paper by Hendrik Bessembinder found that long-leveraged single stock ETFs issued since 2022 underperform a simple frictionless leverage benchmark by an average of 0.79% per month — more than 9 percentage points per year. Of that shortfall, 0.26 percentage points comes from daily rebalancing costs and 0.53 percentage points from fees and financing frictions.

Critically, much of the financing cost in leveraged single stock ETFs doesn't appear in the stated expense ratio. Leverage is often implemented through swap contracts, with the cost baked into the contract price rather than disclosed as an explicit fee. Investors comparing expense ratios may not see the full picture.

Add to this the fundamental problem of individual stock exposure. Most individual stocks underperform a broad market index over their lifetimes. Many suffer large permanent losses. Applying 2x leverage to an asset with these characteristics amplifies both the volatility and the downside asymmetry. For retail investors, the expected outcome is not attractive.

What Good Looks Like — and How to Find It

None of this means ETFs as a category have failed. Index ETFs remain one of the most effective tools available to long-term investors. The underlying logic — broad diversification, low costs, market-rate returns — is sound and well-supported by decades of evidence.

The challenge is navigation. With ETF numbers now exceeding individual stock counts in the US, the signal-to-noise ratio has deteriorated significantly. Here's a practical framework for separating useful products from slop:

• Prioritise fee minimisation: index ETFs with fees below 0.1% exist for most major asset classes. Any product charging 0.7% or more needs a compelling, evidence-based justification
• Demand simplicity: if you cannot clearly explain what an ETF holds and how it generates returns in two sentences, that's a warning sign
• Check the benchmark: any active or complex ETF should be measured against the cheapest passive alternative covering the same market. Most will underperform it over time
• Ignore yield as a standalone metric: high distribution yield from covered calls or complex structures is not free income. It is a trade-off with total return
• Review your asset allocation before adding complexity: if a product appeals because your portfolio feels too risky, the answer is almost always to reduce equity exposure through allocation — not to add a high-fee product designed to manage that risk for you

The fund industry will continue to launch new products as long as investors buy them. Understanding the structural incentives behind ETF slop — and the behavioral biases it exploits — is the most durable defence available.

Frequently Asked Questions

What is an ETF and how does it differ from a mutual fund? An ETF, or exchange-traded fund, is a fund that trades on a stock exchange like an individual stock. Unlike traditional mutual funds, which are priced once per day after markets close, ETFs can be bought and sold throughout the trading day. Both can hold a wide range of investment strategies — from simple index tracking to complex options-based approaches — but ETFs have historically been associated with lower fees and passive index strategies, though that is changing rapidly.

Why are so many new ETFs actively managed when index ETFs have a strong track record? The ETF market for straightforward index funds is dominated by large, low-cost providers. For a new entrant, launching another S&P 500 index fund makes little commercial sense. Active and complex ETFs command higher fees and can be differentiated through marketing, making them more profitable to launch. The incentive structure of the fund industry points toward product proliferation, not simplicity.

Are buffer ETFs a good way to protect against market downturns? The evidence suggests they are not optimal for most investors. Research indicates that buffer funds frequently deliver inconsistent downside protection in practice, particularly outside their narrowly defined target periods. More importantly, a simple combination of equities and cash has been shown to match or outperform buffer funds on average — including during drawdowns — at a fraction of the cost. Investors concerned about portfolio volatility are generally better served by reviewing their overall asset allocation.

What should I look for when evaluating an ETF? Four factors matter most: the total cost (including any hidden financing costs beyond the stated expense ratio), the underlying strategy and whether it can be replicated more cheaply, the benchmark comparison over a meaningful time period, and the product's historical behaviour relative to what its marketing materials promise. For most long-term investors, a diversified, low-cost index ETF covering global equities remains the most evidence-backed starting point.

Why do covered call ETFs show high yields if they underperform their underlying index? Covered call ETFs generate income by selling call options on the stocks they hold. The premiums collected are distributed as yield, which can appear very attractive. However, selling those options caps the fund's participation in any upside. Over time, particularly in rising markets, this trade-off tends to result in lower total returns compared to simply holding the underlying equity. The high yield is a redistribution of potential capital gains into current income — not additional return created from nothing.

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This article is for informational purposes only and does not constitute financial advice. Always consult a qualified financial professional before making investment decisions.