The $5 Trillion ETF Opportunity Hiding in Plain Sight

It is not, which, if you are reading this, you probably already know. For a decade, the waves were easy to ride. Low-cost index funds pulled investors out of mutual funds.

Then active, model portfolios, and thematics took their turns, then crypto and leverage gathered the assets and the excitement.

Sports betting, sorry, prediction markets, funds are next, which feels like a long walk from investing, though arguably no riskier than a 3x leveraged ETF on an already volatile single stock.

The trouble is that a small club of legacy giants absorbs nearly all the new capital, while the crowded field of newcomers fights over the rest with lottery-like home runs.

Roughly 90% of recent launches likely operate below breakeven, and the ratio of annual ETF inflows to new product launches has fallen more than 30% from its post-pandemic peak, from $1.88 billion to $1.28 billion in 2025.

More money is coming in than ever, and less of it is finding new funds. However, there is a massive opportunity for indie and midsize fund sponsors to reliably gather assets and build thriving businesses in a corner of the market where the "big dogs," as Bloomberg's Eric Balchunas calls them, won't compete, for now.

We published a research paper on ExchangiFi this month that asks two questions. How much American equity wealth is locked in place by embedded gains, not sold due to potential taxes, and how much of it could make sense to move into ETFs through a Section 351 exchange? The answer we arrived at is $5.0 trillion across three distinct pools. The pools are more interesting than the headline, and financial advisors should be aware of them too.

A quick Section 351 refresher.

Section 351 lets you contribute property to a corporation in exchange for its stock without recognizing gain. An ETF is, legally, a RIC, a registered investment corporation, and its shares are technically stock in the RIC.

Put those together, and an investor can hand a diversified portfolio of stocks to a newly launching ETF, receive ETF shares back, carry the old cost basis forward, and defer the gain.

Cambria, Alpha Architect, Polen Capital, Avantis, recently DFA, and many other ETF issuers have been seeding new ETFs with hundreds of millions of dollars of securities, not cash.

Pool 1 - Concentrated Single Stocks: #2.9 Trillion

Founders, executives, early employees, the person who bought Apple in 1997, and never looked at the account again.

These people did not choose concentration as a strategy.

Concentration is just how the wealth was made. A 351 exchange lets them fold that position, alongside other securities, into a diversified ETF and keep compounding into retirement.

Pool 2 – Aged Direct Indexing Accounts: $1 Trillion

Direct indexing and tax-loss-harvesting strategies generate losses that offset gains elsewhere.

But markets mostly go up, and after enough years, there are no losers left to sell, and the investor is left holding appreciated stocks in a strategy that has stopped doing the thing it was supposed to do.

Selling would trigger the taxes that the strategy spent years deferring.

Contributing the tangle into one ETF via 351 folds it into a single fund. It is the inevitable outcome for a tax overlay that has run its course.

Pool 3 – Taxable Active Equity SMAs: $1.1 Trillion

Active managers turn over 30% to 70% of a portfolio each year. In a taxable account, every trim and rotation realizes gains, costing an estimated 100 to 200 basis points of after-tax return.

If your manager targets 200 basis points of alpha and hands 150 back to the IRS every year, after fees, you are likely worse off.

Moving the SMA into an ETF wrapper defers the gains and, thanks to in-kind creation and redemption, lets the manager keep rebalancing without mailing the client an annual tax bill.

Notably excluded: roughly $150 billion in leveraged long/short tax-aware strategies, which cannot be 351-exchanged because short positions are liabilities, not property, and liabilities cannot be contributed in kind.

Those investors are staying at the Hotel California.

Now for the catch. Section 351 (e) exists specifically to stop people from pooling concentrated stock to get immediate diversification.

So, each contributor must follow RIC diversification requirements, no single security over 25% of the contributed basket, and the top five holdings cannot exceed 50% combined. In practice, that means at least 11 single stocks.

Regulators are also watching for “stuffing,” which is contributing appreciated assets that do not fit the fund's actual strategy.

The common hesitation is that this looks like a tax dodge. But compare a 351 exchange to what these investors actually do, which is borrow against the stock, spend the loan proceeds tax-free, and die.

At that point, Section 1014 steps up the basis, the gain vanishes permanently, and the Treasury collects exactly nothing.

A 351 exchange carries the old basis into the ETF, so the gain stays on the books, deferred but alive, taxable when the shares are eventually sold.

Against that realistic alternative, the conversion is most likely revenue-neutral. And it unfreezes capital, leaving retirement savings more diversified and markets more efficient.

What this means for the ETF industry is the interesting part. Section 351 targets money that is just sitting there, waiting to be scooped up.

Just a few converting accounts can seed a fund with more assets before launch than years of organic inflows, and no fee war is required to win them.

The constraints are not demand, nor issuer creativity, though the 6th space ETF suggests that well may be running dry, it is advisor education and operational workflow.

That makes this a rare window for small and mid-sized ETF sponsors. The giants have mostly stayed out, though DFA's recent Section 351 launch suggests the chance to gather this $5 trillion uncontested is already narrowing.

The other side of the opportunity is huge for independent RIAs. The wirehouses will not help their clients execute a 351 exchange, so the advisor who walks into a prospect meeting with a plan for the untouchable position can walk out with the client and a lot of new assets to advise.

Disclaimer

Please note this contributor article is for informational purposes only and does not constitute investment advice, a recommendation, or an offer to buy or sell any financial instrument. While the content is provided by a third party and believed to be reliable, we make no representations or warranties as to its accuracy or completeness and accept no liability for any errors, omissions, or outcomes arising from its use. Section 351 transactions are complex and fact-specific. It is essential that you seek advice from a registered financial professional and qualified tax counsel prior to making any investment decision. You should seek advice from a qualified and registered financial professional before making any investment decisions.