While still representing a relatively small portion of the roughly $9 trillion ETF universe, actively managed ETFs are exploding in popularity. Consider this: Active ETFs now represent nearly 9% of ETF assets under management, up from roughly 2% in 2019, according to data from Morningstar.
Let's explore actively managed ETFs and whether they are right for you.
ETF universe expanding
There are more active ETFs (1,473) than ever before (Source: Bloomberg, Jun-30-2024). New active ETFs are launching on a regular basis, and many mutual funds are converting to actively managed ETFs. Many investors and financial advisors like ETFs because they can offer tax advantages compared to some other investment vehicles, can be traded intraday, and offer transparency into underlying holdings, among other potential benefits. Perhaps most importantly, investors and advisors have gravitated to ETFs due to their generally lower relative cost.
Investors might pick actively managed investments (like many mutual funds and ETFs) based on the belief that rigorous research, sophisticated portfolio construction, and expert trading may add value for shareholders. Actively managed ETFs are a portfolio of subjectively chosen investments by a fund manager, rather than those chosen via a rules-based index that defines a passively managed ETF.
Essentially, active ETFs combine the potential benefits of an ETF structure with those of active management. The idea is to perform better than a benchmark index through flexible active management.
In 2019, a rule was passed by the Securities and Exchange Commission (SEC), that made it easier for companies to create and sell ETFs. This allowed a faster and more efficient way for companies to bring ETFs to the market for investors with the goal of fostering more innovation and competition in the industry.
The rule change has steadily made actively managed equity ETFs more widely available in the marketplace. Data from Morningstar shows that active ETFs have added nearly $400 billion of inflows over the past 5 years, as of April 2024, suggesting the trend may be in the early innings.
Of course most, if not all, of the risks associated with ETFs also exist for actively managed ETFs. However, with active strategies in ETF wrappers, investors can gain access to professional managers who seek to anticipate or react to market changes based on a pre-determined strategy and provide more alpha opportunity than an index or passive product can.
The value of research
As part of a fund's management fee, investors pay active managers to conduct company research to identify stocks that might outperform and those that might underperform. Such research decisions have the power to add to shareholder returns.
However, those returns may take time to materialize in trading activity across a suite of funds, as individual managers make investment decisions based on their specific portfolio construction and risk mandates.
Flexibility to trade over time may enhance performance
To determine how quickly to build or reduce a position, traders use their expertise to balance the cost of liquidity with the risk of not executing a trade all at once (should market volatility lead to significant price changes). Because mutual funds and ETFs often trade in large volumes, asset managers frequently spread trades out over multiple days to reduce costs.
In addition to trading flexibility, the ETF vehicle offers potential additional benefits, including tax efficiency. Due to the in-kind creation/redemption process, ETFs are generally tax efficient, with investors typically realizing a gain (or loss) only when they exit a position.
Investment implications
The shift to enable some firms to offer ETFs without the requirement to disclose holdings daily may help reduce the potential costs to shareholders associated with full transparency. At the same time, active ETF structures are designed to provide transparency into the funds’ holdings and drivers of performance. And market demand from investors who are seeking the benefits of ETFs and who believe in the potential of active management has clearly shown an appetite for such investments.