The actively managed exchange traded fund category appears to be gaining momentum with the recent success of the PIMCO Total Return ETF (NYSEArca: BOND). There has been a slew of active ETFs recently launched, which has led many to wonder how active management is defined with an ETF.
“The active ETF universe is ‘heterogeneous,'” Robert Goldsborough of Morningstar said, though heavily skewed toward fixed income. “There are a lot of unique strategies, but not a lot of mainstream equity entries yet.”
It’s also still just a tiny sliver of the industry: Active ETFs have just under $7 billion altogether, Goldsborough says. There’s $1.2 trillion in U.S. ETFs. [Why PIMCO Total Return ETF is Beating It’s Mutual Fund Counterpart]
The definition of active management in the ETF industry is subjective. Index Universe goes by the Securities and Exchange Commission’s definition where index funds reflect changes within the stock weightings of the tracking index immediately, but actively managed funds can wait a day, reports Chris Gay for US News.
However, Morningstar defines active management with whether or not the ETF in question lists a benchmark index. If the prospectus does not list one, it is likely actively managed. [Will ETFs Replace Money Market Funds?]
The following active ETFs represent about two-thirds of the total assets under management in this category:
- PIMCO Total Return (NYSEArca:BOND) $2.5 billion in AUM
- Enhanced Maturity Strategy ETF (NYSEArca: MINT) $1.9 billion
- WisdomTree Emerging Markets Local Debt ETF (NYSEArca: ELD) $1.2 billion
Benefits of an active strategy include the ability to beat the market, with the luck or knowledge of a good manager. The transparency factor is negotiable – many say that active funds are fully opaque, but others argue that all ETFs are transparent. [An Emerging Market Debt ETF For Growth]
Active ETFs present challenges for investors because they are more expensive than passive funds, and higher expenses do not equal higher returns. Also, the ability to trade both active and passive funds is not necessarily a plus. Too many trades can equal higher fees. Some industry insiders argue this creates too much of a short term mindset, rather than focusing in on the big picture for the long term.
There’s one big advantage to these highly complicated, but still technically index ETFs: The Securities and Exchange Commission is not allowing new actively managed ETFs to use derivatives, reports Mike Hogan for Barron’s.
Tisha Guerrero contributed to this article.