Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 10: Adhere to a Strategy]

Actively managed exchange traded funds, ETF managed portfolios or simply active ETFs include a manager or a team of analysts that help make informed decisions on the underlying portfolio’s allocations in an attempt to provide above-average returns. In other words, they do not follow the passive indexing found in most ETF strategies. [What is an ETF? — Part 2: Indexing]

The team behind the fund will have the freedom to trade outside of a benchmark index and the flexibility to take advantage of short-term moves within the markets. Accordingly, active funds may under- or outperform a similar benchmark index, depending on the skill and prowess behind the management team.

Since there is an active management team behind the ETFs’ daily operations, investors will have to dish out a higher than average expense ratio to cover the management fees. Potential investors should keep in mind that the ETF industry average expense ratio is about 0.55%.

Active ETFs may include stocks, bonds, cash equivalents and even other ETFs within their portfolios. The ETF strategies may vary, tracking an investment manager’s specific picks, reflect a mutual fund or adhere to an investment objective.

However, actively managed ETFs have not caught on, representing only 0.5% of the $1.2 trillion ETF market, as the role of arbitrage in ETFs have deterred providers. Since ETFs have to provide full transparency to Authorized Participants to keep an ETF’s price close to its net asset value, active ETFs may be open to front running, or investors trying to mimic a fund manager’s secret sauce. [In-Kind Creations and Redemptions]

For past stories in this series, visit our “What is an ETF?” category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.