Actively managed ETFs have now been in existence for several years. However, they may have advisors who are more accustomed to the mutual fund model scratching their heads, since on the surface at least, they seem nearly identical.
But there are some big differences between the two products that might help you decide whether it’s worth switching over to these ETFs from mutual funds.
It may seem contradictory to have a manager picking stocks, since until recently, ETFs have been known primarily for the fact that they passively track indexes. Proponents of active ETFs believe that both ETFs with active management and those that are passively managed are able to coexist, as they serve different needs within a portfolio.
There are also benefits to be had in actively managed ETFs that you simply can’t get with a mutual fund.
Active ETFs have lower expense ratios, better tax advantages, greater transparency and better trading flexibility. An actively managed ETF will cover a benchmark index, but managers may decide to change sector allocations, market-time trades or trade outside of the benchmark. The greater freedom given to managers makes it more difficult for investors to anticipate the future makeup of the portfolio and the strategy also produces returns that will not reflect the underlying index.
If you’re comfortable with ETF products already available but want to dabble in other investment tools, the transition from passive to active may open up a broad range of active strategies that can offer standalone strategies or matched to enhance a portfolio. Active ETFs expand the flexibility of asset allocation decisions since one is able to choose passive management, active management or both within the vast ETFs product line.
The Benefits of Active Management
Some of the major benefits you can get out of actively managed ETFs are:
- Transparency: Like index-tracking ETFs, actively managed ETFs are required to disclose their holdings daily. While this reporting may not be down to the minute, you do have access to holding information at the end of each trading day. Contrast this with mutual funds, which are only required to disclose holdings quarterly.
- Lower Cost: The average cost of a mutual fund is 1.54%. That might seem like a tiny amount, but multiply that over years and it could potentially be tens of thousands of dollars. The average actively managed ETF expense ratio is 0.61%.
- Liquidity: Active ETFs can be bought and sold like any other ETF – all day long on an exchange. Mutual funds can only be bought and sold at the end of each day.
- Benefit of Brains: Like with mutual funds, you still get the benefit of an expert who knows his or her stuff trading within the fund.
- Better Tracking of Asset Classes: Certain asset classes simply work better with the active management model, for example, bonds. An actively managed portfolio of bonds can give you exposure to the right bonds at the right time.
Actively Managed ETFs: The Next Big Thing?
Although active management in ETF form is a good idea and better serves investors than mutual funds, investors have been slow to adopt them.
But that doesn’t mean that there hasn’t been a lack of interest in actively managed ETFs if you consider the number of SEC filings that we have seen from existing ETF providers, big-name banks and even companies that are known more for their mutual funds.