An actively managed ETF is a type of exchange-traded fund in which the underlying portfolio allocation is decided by a manager or team, rather than following a passive investment strategy.
Although an actively managed ETF will have a benchmark index, managers can adjust sector allocations, make market-time trades, and diverge from the index as they see suitable. This results in investment returns that aren’t exactly the same as the underlying index.
Are actively managed exchange-traded funds (ETFs) beneficial?
Before adopting one of these investment options, it’s critical to understand the potential benefits and drawbacks of typical actively managed ETFs. The following are some of the benefits of this investment above others:
- Higher returns are possible. Actively managed ETFs have the potential to beat the benchmark through investing decisions made by portfolio managers and research analysts, whilst passively managed ETFs try to replicate the performance of a benchmark. Of course, the fund could also underperform its benchmark.
- Possibly less expensive than related funds. When compared to a comparable mutual fund, the structure of an actively managed ETF can allow it to have lower expenses.
- Efficient taxation. Because the process of creating and redeeming shares is done “in-kind,” it is not a taxable event, it is possible that ETFs are more tax-efficient than equivalent mutual funds. 2
- Flexibility. Actively managed ETFs, like index ETFs, allow investors to trade at any time of day, including short sells and margin purchases. 3 This may also provide ETFs with more liquidity than funds that do not trade throughout the day.
Traditional actively managed ETFs, of course, have their drawbacks. These are some of them:
- Disclosure is required on a daily basis. Larger funds, as well as those that hold illiquid securities, may face this issue. For fear of front-runners and other traders in the marketplace, full disclosure may limit an active manager’s capacity to make modifications and apply a plan with internal investment research in the portfolio. This criterion does not apply to semi-transparent ETFs.
- Departure from the NAV. On volatile trading days, traditional actively managed ETFs may build substantial premiums or discounts to NAV. These ETFs may experience higher premiums/discounts to NAV than passively managed ETFs. 4
- Certain funds have higher charges. Actively managed ETFs may have lower expenses than comparable mutual funds, but their expense ratios may be greater than index-trading ETFs.
How can you know if an ETF is managed actively?
An index fund or an ETF are both examples of passively managed funds. In addition, the summary overview of a fund will state whether it is an index fund or an exchange-traded fund (ETF). If it doesn’t, it’s safe to think it’s being actively managed. For example, Vanguard’s REIT ETF (VNQ) declares that it is an ETF and that it invests in REITs.
The goal is to closely replicate the MSCI US Investable Market Real Estate 25/50 Index’s performance.
There are some slight variations between ETFs and index funds when it comes to investing. The most significant difference is that ETFs trade on the stock exchange throughout the trading day, whereas index fund transactions, like other mutual funds, take place at the conclusion of the trading day. Many online brokers offer commission-free ETF trading for a variety of ETFs, and the expense ratios of index funds and ETFs offered by the same provider are quite comparable, if not identical. Some index funds have high minimum opening deposits, making their ETF equivalents more accessible.
Simply look through the company’s list of ETFs or index funds to see which are on the list to discover if your funds are actively or passively managed. Vanguard has the lowest management expense ratios (and why not go with the cheapest if you’re going with a passively managed fund that tracks an index?). Here are a couple of places to begin:
Unfortunately, actively managed funds still account for a big portion of invested assets (at the price of investor performance), but you now have the knowledge to help alter that!
What is the difference between a mutual fund and an actively managed ETF?
- In past years, mutual funds were generally actively managed, with fund managers actively purchasing and selling securities inside the fund in an attempt to beat the market and assist investors benefit; however, in recent years, passively managed index funds have grown increasingly popular.
- While ETFs were traditionally passively managed because they tracked a market index or sector sub-index, a growing number of actively-managed ETFs are now available.
- ETFs and mutual funds are distinguished by the fact that ETFs can be bought and sold like stocks, whereas mutual funds can only be purchased at the conclusion of each trading day.
- Fees and expense ratios for actively managed mutual funds are often higher than for ETFs, reflecting the greater operating costs associated with active management.
- Mutual funds can be open-ended (where trading takes place between investors and the fund and the number of shares available is unlimited) or closed-end (where the fund issues a fixed number of shares regardless of investor demand).
- Exchange-traded open-end index mutual funds, unit investment trusts, and grantor trusts are the three types of ETFs.
How are actively managed ETFs profitable?
Because actively managed ETFs are more difficult to create, they are not as commonly available. All of the primary challenges that money managers face are related to a trading complexity, notably a complication in the role of arbitrage for ETFs. Because ETFs are traded on a stock market, price differences between the trading price of the ETF shares and the trading price of the underlying assets are possible. Arbitrage becomes possible as a result of this.
If the price of an ETF is lower than the price of the underlying stock, investors can profit from the difference by purchasing ETF shares and then exchanging them for in-kind distributions of the underlying company. Investors can short the ETF and cover the position by purchasing shares of stock on the open market if the ETF is trading at a premium to the value of the underlying shares.
Arbitrage keeps the price of index ETFs near to the value of the underlying shares with index ETFs. This works because everyone is aware of the index’s holdings. By declaring their holdings, the index ETF has nothing to fear, and price parity is in everyone’s best interests.
An actively managed ETF, whose money manager is compensated for stock selection, would be in a different scenario. Those choices should, in theory, help investors exceed their ETF benchmark index.
There would be no motivation to buy the ETF if it published its holdings frequently enough for arbitrage to occur; clever investors would just let the fund management conduct all of the research and then wait for the revelation of their best ideas. The investors would then purchase the underlying securities, so avoiding the fund’s management costs. As a result, money managers have little motivation to establish actively managed ETFs in such a circumstance.
However, in Germany, Deutsche Bank’s DWS Investments business produced actively managed ETFs that reveal their holdings to institutional investors on a daily basis with a two-day delay. However, the information is not released to the broader public until it has been one month. This setup allows institutional traders to arbitrage the fund, but also feeds the general public outdated information.
Active ETFs have been permitted in the United States, but they must be transparent about their daily holdings. In 2015, the Securities and Exchange Commission (SEC) disallowed non-transparent active ETFs, but it is now considering several models of regularly reported active ETFs. On volatile days involving ETFs, the SEC has also permitted opening stock trading without price disclosures to avoid the record intraday drop that occurred in August 2015, when ETF prices fell as securities trading paused while ETF trading continued.
Vanguard ETFs are actively managed, right?
With these two funds, portfolio size is less of a problem. SIZE has 620 holdings compared to 779 for VFLQ. They don’t share any of their top ten holdings, and technology isn’t their major industry.
Instead, financials is the largest sector for both VFLQ and SIZE, with 32.8 percent for VFLQ and 21 percent for SIZE. However, technology is the second-largest sector in SIZE, while it is the fourth-largest in VFLQ.
Despite its concentration on the liquidity factor, VFLQ has the higher factor exposure to low size, with an exposure of 1.66, whilst SIZE has an exposure of 0.61 to the same factor.
The funds’ performance differential at the end of the two-year period appears to be driven by technology exposure and small-size exposure, with VFLQ behind SIZE by 15 percentage points.
Vanguard is recognized for its passive investing, but it doesn’t skimp on active management, offering a wide range of actively managed mutual funds. It’s remarkable that its actively managed ETFs underperform similarly managed passive products by such a large margin.
The Vanguard ETFs, on the other hand, are often underweight in the technology sector, which has outperformed in recent years. Similarly, many Vanguard funds have significant low-size factor exposure, and small caps have recently underperformed.
Is Fzrox under active management?
The Fidelity ZERO Total Market Index Fund (MUTF:FZROX) and the Fidelity ZERO International Fund (MUTF:FZILX) are two mutual funds that will cost investors nothing to acquire and hold. This is fantastic news for investors.
What makes actively managed ETFs so appealing?
Actively managed ETFs are similar to actively managed mutual funds in that they are actively managed. Both are expected to have higher compositional turnover than their indexed counterparts, and fund managers play a significant role in deciding which holdings to invest in. However, there are a few important distinctions between them.
Actively Managed ETFs Trade Like Stocks
Active exchange-traded funds (ETFs) trade like stocks. Throughout the trading day, they can be bought and sold as often as needed. Mutual funds, on the other hand, only trade once a day, at the end of the trading day.
For investors who want to add some active management to their portfolios, this disparity may not be significant. Both types of actively managed funds have managers who react to market developments in real time, and investors purchase a fund to benefit from its longer-term investing strategy.
The stock-like tradability of actively managed ETFs is important for another reason: You’ll need to stick with active ETFs if you want to buy an actively managed fund in a margin account. You can’t buy mutual funds on margin in most situations.
Actively Managed ETFs Offer Better Tax Efficiency
The tax efficiency of an actively managed ETF is one of its largest benefits. ETFs have fewer taxable events than mutual funds since your money is used to purchase what are known as creation units rather than fund assets.
“Because mutual funds’ assets are purchased and sold, gains are distributed rapidly, according to Meadows. “You’ll have to pay capital gains taxes, which could be low or substantial, depending on how frequently the securities are exchanged in and out of the fund.”
When you sell your ETF shares, however, you only receive capital gains. For those who have active funds in retirement accounts such as 401(k) or Individual retirement accounts, this distinction may be less important (IRAs). Active ETFs, on the other hand, may offer tax advantages to investors who invest in taxable brokerage accounts.
Actively Managed ETFs Have Lower Investment Minimums
To buy mutual fund shares, you may need to meet a high investment minimum, depending on the broker. These minimums can be thousands of dollars, which can make it difficult to invest in a fund. Because ETFs have lower investment minimums than active funds, you may be able to get started investing in an active fund sooner or with a lower initial investment.
Mutual Funds Offer Less Transparency
Friedman claims that, despite the SEC’s new guidelines allowing for less openness in actively managed ETFs, mutual funds remain the least transparent investment vehicle.
“Actively managed ETFs must nonetheless reveal their tracking baskets more frequently, according to Friedman. “Mutual funds may only have to report their holdings once a quarter and are not required to reveal as much information.”
If fund transparency is important to you, actively managed ETFs may be preferable to actively managed mutual funds.
Why are active exchange-traded funds less expensive than mutual funds?
When you want to buy or sell an active mutual fund, you can do it only once a day, at 4 p.m. ET, and at a price that you won’t know about until after the fact. This approach has the advantage of assuring investors that their shares would be traded at the fund’s net asset value (NAV). However, investors do not have access to this NAV in advance and do not know what the fund’s NAV is on a daily basis, as mutual funds only release the closing NAV at market close.
Because they are exchange-traded, like stocks, actively-managed ETFs differ greatly in this regard. This implies that, much like a stock, you may see the indicative value for an Active ETF at any time during the day.
However, note that I used the term “indicative value” rather than “net asset value.” An Active ETF’s share price may differ from the fund’s genuine NAV because it trades on the secondary market. The market maker or designated broker, on the other hand, has an incentive to keep the share price as close to the NAV as possible since they can arbitrage between the share price and the fund NAV, decreasing the divergence.
Because exchange-traded funds are available to buy and sell at any time when the market is open, investors may view the fund’s current price at any time, and they can utilize limit prices, margin, and even short the fund just like any other stock.
Lower Expenses
The expense ratios of most actively-managed ETFs are lower than those of the average active mutual fund that offers investors exposure to a similar strategy. This is due to the fact that ETFs are less expensive to operate than mutual funds and the fund administration process is simpler. ETFs do not require the same size shareholder service departments as mutual funds.
ETFs do not pay trailer fees to financial advisors who advocate them to investors, which is another crucial element that leads to cheaper expenses. Traditional investment advisors may receive a trailer charge of up to 1% on mutual funds, which is added to the total expense ratio (TER), which is the headline expense that investors see. As a result, Active ETFs are on average less expensive for investors than comparable active mutual fund strategies.