When most investors think of exchange-traded funds (ETFs), they think of passive investing strategies. These funds track a wide variety of indexes and sport low turnover and cost as well as high diversification opportunities.
Passive investing has become a favored method for investors of all stripes, as analysts cite studies showing that passive strategies tend to win out overactive ones in the long term. Nonetheless, there are also actively managed ETFs, although they tend to slip under the radar.
Despite the fact that only a minority of actively managed funds will beat the market, some investors are interested in pursuing these larger profit goals. In this way, the design of ETFs can help the active investor strategy as well. ETFs allow intraday trading; this is in opposition to mutual funds, which trade just once per day. With intraday trading, ETF investors have the chance to track the direction of the market and make trades within the day accordingly, thereby aiming to take advantage of short-term shifts.
Key Takeaways
- An actively managed exchange-traded fund (ETF) has an investment manager or team responsible for researching and making decisions about the ETF's portfolio allocation.
- While passively managed ETFs greatly outnumber actively managed ETFs, investor interest in active ETFs has prompted major growth in the category.
- Benefits of active ETFs include lower expense ratios compared to mutual fund equivalents, the ability to trade intraday, and the potential for higher gains.
- Over the long term, passively managed ETFs tend to outperform actively managed ETFs.
Actively Managed ETFs
The most common ETF design tracks a particular index. However, ETFs can also be built to track the top picks of an investment manager or a mutual fund, for example. In this way, these ETFs would mimic an actively managed strategy. They would also aim to provide above-average returns. ETFs that are actively managed can also provide a benefit to mutual fund investors and to fund managers, too.
An ETF that tracks a mutual fund, for example, will likely appeal to frequent traders over the mutual fund itself as a result of the intraday trading capabilities. Thus, with trades focused on the ETF, the mutual fund is less likely to experience cash flow in and out, and the portfolio is likely to be easier to manage and increasingly cost-effective.
Trends in the ETF Space
Traditional, passively managed ETFs still vastly outnumber actively managed ETFs. In the U.S. there are approximately 500 actively traded ETFs, which account for about 20% of all ETFs. Together, active ETFs constitute only $530 billion of the $9.6 trillion ETF space. However, investor interest in the active ETF category has prompted major growth in this area, and it's likely that this trend will continue.
By year-end 2023, the assets under management (AUM) for active ETFs increased by 55% over the previous year. About 73% of all new ETFs launched in 2023 were actively managed and over 75% of firms had positive cash flow. This growth in actively managed ETFs occurred over several asset classes, including domestic and international fixed income, international equity, and commodities.
Active ETFs have even become so popular as to inspire some passive ETFs to include the word "active" in product descriptions and names, even if that term doesn't accurately reflect the strategy of the ETF itself. Investors are thus cautioned to remain vigilant in their research before investing in a product.
Active, non-transparent ETFs (referred to as "ANTs") are ETFs that don't disclose their portfolio holdings daily.
Benefits and Risks
Why invest in an active ETF over a mutual fund, for instance, or another related product? Aside from the benefits of intraday trading, many actively managed ETFs have lower expense ratios than their comparable mutual fund equivalents. They may be cheaper to purchase, depending upon the broker involved. Additionally, some actively managed funds can see exponential growth, particularly those that focus on a specific sector or trend.
For example, ARK Innovation ETF (ARKK) surged 71% in 2023. The active equity ETF, founded in Oct. 2014, focuses on "disruptive innovation." The fund holds companies that are at the forefront of technological and scientific advancements. This includes everything from DNA technology firms, industrial innovators, next-generation Internet companies, and fintech service providers.
That's not to say that actively managed ETFs aren't without risks. ARKK's theme of disruptive innovation did well during the pandemic crisis of 2020 when its holdings in Tesla, Teladoc Health, and Zoom Video Communications surged. It appears active strategies may do better during times of high market volatility, while passive strategies tend to outperform when markets exhibit a higher degree of correlation.
Research still suggests that passive strategies are more effective than active ones over a long period of time. Nonetheless, active ETFs may be gaining momentum within the investor community.
Can Actively Managed ETFs Beat the Market?
Historically, active strategies are unlikely to exceed market returns over the long run, due to the costs of market research and management. However, some research has found that active management strategies can do well during periods of high volatility, when average market returns are poor.
What Is the Best Actively Managed ETF?
While it's impossible to identify the "best" actively managed ETF, the JPMorgan Equity Premium Income ETF was the top performer in 2023 in terms of cash flow. The fund drew $12.9 billion of capital in 2023.
How Many Actively Managed ETFs Are There?
There were 1,255 actively managed ETFs at the end of 2023, according to research by Morgan Stanley. Combined, they manage around $444 billion in assets.
The Bottom Line
Actively-managed ETFs are exchange-traded funds that hire specialists to pick and choose assets for investments, rather than seeking to replicate an index or sector. These funds combine the management strategy of a mutual fund with the ability to buy and sell the fund throughout the trading day. Although they are a minority of ETFs, the number of actively-managed funds is increasing.
