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 over active 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. (For more, see: Introduction to Exchange-Traded Funds.)
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. (See also: Active vs. Passive ETF Investing.)
New Trends in the ETF Space
Traditional, passively managed ETFs still vastly outnumber actively managed ETFs. As of this writing, there are roughly 230 active ETFs, according to a report by US News, and about 50 of those were launched within the past year. Together, active ETFs constitute only a small portion of the $4 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.
A report by ETFGI, a London-based research firm, indicates that active ETFs and related vehicles amassed $24 billion in new assets for the first 11 months of 2017. This marks an increase of more than 50% over the previous year, as well as the largest single-year increase since 2009. 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. (For more, see: Actively Managed ETFs: The New Mutual Funds?)
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. Barron's points to the Fidelity Total Bond ETF (FBND), managed by Ford O'Neil. O'Neil also manages the Fidelity Total Bond mutual fund (FTBFX). Between these two options, the ETF has a lower expense ratio (0.36% compared with 0.45% for the mutual fund). If your broker is Charles Schwab, buying the ETF will cost $4.95 as opposed to $76 for the mutual fund.
Is there a benefit to choosing the mutual fund? According to O'Neil, in this case, the answer is no. "We're agnostic as to which channel people want to invest [in], he explains. We try to run the two funds in a very similar manner."
That's not to say that actively managed ETFs aren't without risks. Research still suggests that passive strategies are more effective than active ones over a long period of time. Nonetheless, active ETFs seem to be building momentum within the investor community. (For additional reading, check out: Actively Managed ETFs: Risks and Benefits for Investors.)