201: ETFs vs. Mutual Funds and Active vs. Passive ETFs | 'The Switch' with ARK Invest

This season of “The Switch” brings discussions about the mechanics of exchange traded funds. On this first episode of the second season, host Ren Leggi, Client Portfolio Manager for ARK Invest, and ETF Trends CEO Tom Lydon and CIO Dave Nadig discuss ETFs versus mutual funds and active versus passive ETFs.

The discussion opens with Leggi explaining that ARK offers a wide range of investment vehicles, from the retail end all the way to pension funds and sovereign wealth funds. They each offer certain advantages and disadvantages, and having such a wide offering allows ARK to tailor the investment options to each client’s needs.

“What we’ve seen is a lot of demand for our actively managed ETFs,” Leggi says.

Nadig explains that the big draw of ETFs is their transparency, tax efficiency, and liquidity, which Leggi believes are all important factors that play into investing with ARK.

Taxation is an important component for ARK as they tend to trade frequently, which can incur capital gains. The ETF structure and tax efficiency helps to offset the tax burden that some investment vehicles can have.

Leggi goes on to discuss what he believes to be one of the most important and least talked-about advantages of ETFs regarding how they handle liquidity. “From a portfolio manager’s perspective, how liquidity isn’t kind of an area of concern because it’s handled by third parties” is an important distinction that doesn’t get recognized very often.

When asked what he personally likes most about ARK’s investing strategies, Nadig explains that their transparency is something he finds valuable, particularly for active managers.

“I think there’s something to be said for not only talking your book but showing it over and over again, why you’re doing something when you’re doing it,” Nadig says. He goes on to explain that in order to run an ETF that is truly active, because of the structure, a fully transparent approach is the only one that really makes sense.

Having that level of transparency gives investors confidence, particularly as they work to balance the holdings in their portfolio. Knowing what securities an actively managed ETF is invested in allows for balancing with other funds and prevents unanticipated overlap or weighting in a security or sector that an investor may not have wanted.

The Perks of Active Management

Leggi explains that a benefit to active management funds is that they allow for movement and response, a quality he describes as being “very nimble.” Another major benefit to active management, Leggi says, is that fund managers are never backed into a corner and forced to buy or sell anything, something that passively managed fund managers often must do in certain market conditions.

Combining the benefits of active management with an ETF just makes sense to Leggi; “it makes it a lot easier from a portfolio management perspective in that you don’t have to worry about all the other mechanics,” he said. Leggi notes that a current trend that ARK is experiencing is a push by investors for actively managed, innovative ETFs, such as thematic ETFs.

ARK is a company that tends to defy the norm when it comes to active performance versus the benchmarks over time. Most companies that run active management, semi-transparent funds typically underperform versus the benchmarks over longer timeframes, whereas ARK stays fairly consistent in providing positive results. Leggi chalks it up to how unique they are, both within the asset management industry and within the active management arena.

Most companies that use active management begin with a benchmark and then build from there with a goal to outperform that particular benchmark. It creates a lot of overlap between the performance of the actively managed fund and the performance of the benchmark.

ARK is unique in their approach. They are “completely agnostic,” as Leggi describes it, in that they don’t manage to a benchmark, but instead to innovation. Innovation is “global in nature; it cuts across market caps; it cuts across sectors,” Leggi explains, and so in pursuing innovation, ARK funds end up with very low overlap with any particular benchmark.

“We’re providing forward looking exposure to these massive opportunities, so we’re unique in that respect. We’re not trying to provide or overlap with investors’ core portfolios, many of which may be more passive,” Leggi says. “We’re looking for the next group of FAANG stocks, and we want to be positioned to benefit from that over the next five to 10 years.”


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