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Exchange-traded funds, or ETFs, are one of the most popular investments because of their low costs, diversification benefits and liquidity. Most ETFs are passive, meaning they track an index such as the S&P 500 or Nasdaq Composite. But actively managed ETFs have burst onto the investment scene in recent years and have attracted interest from investors.
Here’s what you should know about active ETFs.
What is an actively managed ETF?
Active ETFs are managed by professional investors in an attempt to outperform a market index such as the S&P 500. A portfolio manager and a team of research analysts work to identify investments they think will do better or worse than the overall market and then position the fund’s portfolio accordingly.
Historically, actively managed funds have mostly been in the form of mutual funds, but active ETFs have grown in recent years, attracting an annual record of $131 billion in assets in 2023, according to Morningstar. ETFs have certain benefits when compared to mutual funds such as tax efficiencies and trading liquidity.
One reason active ETFs had been slow to catch on until recently was the requirement that ETFs disclose their holdings daily. Fund managers didn’t want to disclose their investment strategies just so other traders or investors could take advantage of their work. But in 2019, the Securities and Exchange Commission adopted a new rule, which allowed for semi-transparent ETFs. These semi-transparent ETFs were not required to disclose their full holdings daily, paving the way for more active ETFs.
Pros and cons of actively managed ETFs
Advantages of active ETFs
- Potential to outperform: The main benefit to invest in active ETFs is because of their potential outperformance. A talented portfolio manager may be able to add value over time by selecting the right investments, but as with any investment, there’s no guarantee that will happen.
- Intraday liquidity: ETFs offer intraday, or within the day, liquidity because they trade on an exchange similar to the way that stocks trade. Mutual funds, on the other hand, can only be bought and sold at the end of each trading day at the fund’s net asset value, or NAV.
- Tax efficiency: ETFs can be more tax efficient than mutual funds because of how shares are bought and sold. When mutual funds are redeemed, the fund may have to sell some investments to meet the redemption, which can create a tax liability for continuing fund shareholders. ETFs are only taxable when you sell the fund for a gain.
- Cheaper than comparable mutual funds: Active ETFs typically have lower expense ratios than actively managed mutual funds.
Disadvantages of active ETFs
- May lag passive ETFs: While the goal of active ETFs is to outperform the overall market, that may not happen in reality. In fact, studies have shown that over time, the vast majority of active managers fail to outperform a passively managed fund.
- Higher fees than passive ETFs: You’ll pay higher fees for active ETFs because of the portfolio manager and research team that tries to identify superior investments for the fund. These fees can be justified if the fund outperforms, but if it lags, you’ll have an underperforming investment that you paid more in fees for – potentially paying more for less.
- Unlimited fund capacity: Unlike mutual funds, ETFs can’t close their doors to new investors, which can create challenges for funds with certain investment strategies. For example, a fund that focuses on small-cap companies could reach a size where it’s too big to buy small-cap stocks, upending its strategy.
Bottom line
Active ETFs are a way to combine the tax efficiency and intraday trading of ETFs with the potential for outperformance that comes with an actively managed fund. To be sure, there is no guarantee active ETFs will outperform a passive alternative. The funds will also come with higher fees than those that track broad market indices like the S&P 500.
FAQs
Active ETFs are managed by professional investors in an attempt to outperform a market index such as the S&P 500. A portfolio manager and a team of research analysts work to identify investments they think will do better or worse than the overall market and then position the fund's portfolio accordingly.
How does an active ETF work? ›
Actively-managed ETFs are exchange-traded funds that hire specialists to pick and choose assets for investments, rather than seeking to replicate an index or sector. These funds combine the management strategy of a mutual fund with the ability to buy and sell the fund throughout the trading day.
Are active ETFs worth it? ›
Traditional active ETFs retain the benefits of the ETF wrapper, such as transparency and trading flexibility, with no visible sacrifice on alpha. Active ETFs also offer improved tax efficiency over active mutual funds.
What is the difference between active and passive ETF? ›
Active ETFs hold analyst-selected stocks, attempt to beat the market, and can offer more flexibility to investors. Passive ETFs are typically designed to track an index, may offer more diversification, and tend to have lower fees compared to actively managed ETFs.
What are ETFs and how do they work? ›
An exchange traded fund, or ETF, is a basket of investments such as stocks or bonds. ETFs often have lower fees than other types of funds. ETFs provide instant diversification by investing in many assets at once.
How do you actually make money from ETFs? ›
Traders and investors can make money from an ETF by selling it at a higher price than what they bought it for. Investors could also receive dividends if they own an ETF that tracks dividend stocks. ETF providers make money mainly from the expense ratio of the funds they manage, as well as through transaction costs.
Do active ETFs pay capital gains? ›
Exchange-traded funds (ETFs) have different tax rules depending on their assets. If you sell shares in most ETFs within a year, any profits are taxed as a short-term capital gain. ETFs held for longer are considered long-term gains and given a lower rate.
What is the downside of owning an ETF? ›
ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses.
What is the largest active ETF? ›
J.P. Morgan first got into active ETFs with several fixed-income and alternative/hedge-fund-oriented strategies before the ETF Rule came out. In 2020, the firm launched its crown jewel covered call strategy, JPMorgan Equity Premium Income JEPI, which was the top-ranking active ETF by assets at the end of 2023.
What is the most active ETF? ›
US ETFs that have been traded the most
| Symbol | Vol * Price | Price |
|---|
| QQQ D | 10.688 B USD | 473.24 USD |
| IWM D | 5.068 B USD | 217.61 USD |
| TLT D | 3.128 B USD | 101.33 USD |
| LQD D | 2.896 B USD | 113.71 USD |
39 more rowsThe main types of non-equity ETFs are:
- Bond ETFs. Hold a portfolio of bonds or, in the case of a single-security ETF, a single bond issued by government treasuries, municipalities, private companies, and/or financial institutions. ...
- Commodity ETFs. ...
- Currency ETFs.
With 1571 ETFs traded on the U.S. markets, Active Management ETFs have total assets under management of $754.34B. The average expense ratio is 0.71%. Active Management ETFs can be found in the following asset classes: Equity.
Is it better to invest in active or passive funds? ›
Active strategies have tended to benefit investors more in certain investing climates, and passive strategies have tended to outperform in others. For example, when the market is volatile or the economy is weakening, active managers may outperform more often than when it is not.
What are the top 10 ETFs? ›
ETFs
| Symbol | Price | 200 Day Average |
|---|
| IBIT iShares Bitcoin Trust | 34.10 +1.12 (+3.40%) | 34.50 |
| SPY SPDR S&P 500 ETF Trust | 563.07 +0.23 (+0.04%) | 517.01 |
| SH ProShares Short S&P500 | 11.20 0.00 (0.00%) | 12.12 |
| IWM iShares Russell 2000 ETF | 219.41 +1.80 (+0.83%) | 203.38 |
21 more rowsExchange-traded funds (ETFs) are ideal for beginning investors due to their many benefits, which include low expense ratios, instant diversification, and a multitude of investment choices. Unlike some mutual funds, they also tend to have low investing thresholds, so you don't have to be ultra-rich to get started.
Do you get dividends from ETFs? ›
There are 2 basic types of dividends issued to investors of ETFs: qualified and non-qualified dividends. If you own shares of an exchange-traded fund (ETF), you may receive distributions in the form of dividends. These may be paid monthly or at some other interval, depending on the ETF.
What is the difference between an active ETF and a fund? ›
Most actively-managed ETFs have expense ratios that are lower than those on the average active mutual fund that provides investors with exposure to a similar strategy. This is because, operationally, ETFs are cheaper to run than are mutual funds and the fund administration process is simpler.
What is the average fee for an active ETF? ›
Expense ratios can range from as low as 0.03% for some passively managed ETFs to over 1% for actively managed or specialized ETFs. Factoring in 0.5% to 0.75% for actively managed fees is considered to be around the average.
What are the disadvantages of actively managed certificates? ›
Because an AMC is actively managed, it typically has higher management fees and operating expenses than a passive fund, such as an ETF. Another disadvantage of an AMC is the potential for underperformance. Although active management has the potential to outperform the market, it also has the potential to underperform.
How do you make money with actively managed mutual funds? ›
Investors in the mutual fund may make a profit in three ways:
- The fund may earn interest and dividend payments from its holdings.
- The fund may earn capital gains from selling assets held in the fund at a profit.
- The fund may appreciate, meaning each fund share will grow in value over time.
