What Is an Actively Managed ETF?
An actively managed ETF is an exchange-traded fund with a manager or team making decisions on the underlying investments in the fund. Often, an actively managed ETF tracks a benchmark index, but managers may change sector allocations, market-time trades, or deviate from the index as they see fit to try and meet the fund's objectives.
Key Takeaways
- An actively managed ETF is an exchange-traded fund with a manager or team making decisions about the holdings.
- Generally, an actively managed ETF does not adhere to any passive investment strategy.
- Many actively managed ETFs track a benchmark index, but managers may deviate from it as they see fit.
- Advantages to actively managed ETFs include lower expense ratios than mutual funds and the participation of seasoned financial professionals.
- Many actively managed ETFs have higher expense ratios than passively-managed index ETFs, which puts pressure on fund managers to consistently outperform the market.
How an Actively Managed ETF Works
An actively managed ETF features many of the same benefits of a passively managed exchange-traded fund, like price transparency, liquidity, and tax efficiency, but with a fund manager that can adapt the fund to changing market conditions. The combination of active management and an ETF provides investors with an innovative solution to asset management.
For investors, there is enough to like about actively managed ETFs, such as lower expense ratios than mutual funds and the active participation of seasoned financial professionals. Because these funds only employ highly experienced and proven managers, there is a possibility of gaining benchmark-beating returns.
There are no guarantees thatan actively managed fund will underperform or outperform a passive ETF rival, even with the skills of the managers. Traditional ETFs can at least be counted on to follow an indexfaithfully, which allows investors to knowthe holdings and risk profile of the fund. This helps keep a diversified portfolio in line with expectations.
Fund managers of an active ETF, however, have the freedom to trade outside of abenchmark index, which makes it more difficult for investors to anticipate the future makeup of the portfolio. This can work for investorswhen market conditions experience heavy volatility. An active manager can shift allocationsaway from underperforming positions to more appropriate sectors or asset classes.
In 2018, asset management giant Vanguard rolled out a catalog of actively managed ETFs. The move was a sharp departure from the index-based strategy championed by founder John Bogle for multiple decades.Many of these funds have become popular investment avenues.
Limitations of an Actively Managed ETF
Although actively managed ETFsshare many characteristics ofpassive exchange-traded funds, they tend to come at a premium. Many have higher expense ratios than passive index ETFs, which puts pressure on fund managers to work hard to outperform or beat the market.
As with an actively managed mutual fund, the potential to outperform comes down to the manager's abilities. Some will regularly beat expectations, but most research finds active management to underperform a passive strategy.
Furthermore, actively managed ETFstend to contradict basic investment principles like diversification. The typical fund manager shifts allocations according to market conditions, meaning the fund may be less diversified than a passive ETF.
What Is an Actively Managed ETF?
Actively managed ETFs are not based on an index, instead seeking to achieve a chosen investment objective by investing in a portfolio of bonds, stocks, and other assets. With this type of investment, an advisor may actively buy or sell components in the portfolio regularly without regard to conformity with an index.
What Is the Most Active ETF Sector?
Actively managed ETFs are a popular investment for many investors, with funds flowing constantly in and out of them. According to Fidelity, the most active ETF sector for inflows in 2023 was technology, while healthcare was the most active for outflows.
Is an Actively Managed ETF the Same as a Mutual Fund?
Mutual funds and ETFs are similar in that they both pool funds and assets together and can be actively or passively managed, but that is where the similarities end. The most significant difference is when they can be traded—mutual funds can only be traded after market hours, while ETFs trade throughout the day.
The Bottom Line
Actively managed ETFs are investment vehicles that pool funds and hold a basket of assets while focusing on a specific strategy, such as ETFs that hold covered calls. When an asset fails to meet performance goals, the managers swap it for another, better-performing asset to ensure the fund maintains its returns.
Fees are generally higher in actively managed ETFs because of the activity involved, but this doesn't mean they're not appropriate for an investor's goals. If the fund's performance outweighs the fees, it might be an attractive opportunity for someone who can afford it or doesn't mind paying more for better performance. Conversely, the higher fees can eat into returns, so investors who can't afford them or don't want to pay more should avoid them.
FAQs
Key Takeaways. An actively managed ETF is an exchange-traded fund with a manager or team making decisions about the holdings. Generally, an actively managed ETF does not adhere to any passive investment strategy. Many actively managed ETFs track a benchmark index, but managers may deviate from it as they see fit.
What is a drawback of actively managed funds? ›
Disadvantages of Active Management
Actively managed funds generally have higher fees and are less tax-efficient than passively managed funds. The investor is paying for the sustained efforts of investment advisers who specialize in active investment, and for the potential for higher returns than the markets as a whole.
What are the limitations of managed funds? ›
Disadvantages. There are fees involved when investing in a managed fund, as you are hiring the service of the fund manager to produce returns on your investment. The amount of fees can vary greatly and can have a significant impact on your overall returns.
Can actively managed funds be traded throughout the day? ›
Potential Benefits of Active ETFs
The key difference is that ETFs are traded on stock exchanges, which allows investors to trade ETFs throughout the day as market prices fluctuate. A mutual fund, on the other hand, is traded at the end of the day based on its calculated net asset value.
How are actively managed ETFs different from passively managed ETFs? ›
As the ETF market has evolved, different types of ETFs have been developed. They can be passively managed or actively managed. Passively managed ETFs attempt to closely track a benchmark (such as a broad stock market index, like the S&P 500), whereas actively managed ETFs intend to outperform a benchmark.
What are the risks of actively managed ETFs? ›
The risk of underperforming the benchmark exists, and poorly performing active ETFs may not justify their higher fees. For example, like investors, active managers are susceptible to behavioral biases that can impact investment decisions. Emotional reactions to market movements may lead to suboptimal choices.
What are the disadvantages of active management? ›
On the downside, active management may be more expensive than passive management, and it may also be more time-consuming. Additionally, active managers may be more likely to take on more risk than passive managers.
What are the disadvantages of a managed portfolio? ›
What Are the Disadvantages of Portfolio Management? Portfolio management can be costly, both in terms of time and money. It can also remove project managers' valuable experience from the prioritization equation, a factor that should be considered when deciding to adopt this methodology.
What is the risk profile of a managed fund? ›
Risk Profile
The risk level of a managed fund depends on the asset classes the fund invests in. Investments such as cash or fixed interest are lower risk and aim to provide regular income and protect the capital invested. Growth investments like property or shares are higher risk, but offer a higher potential return.
What are the disadvantages of buying index mutual funds rather than actively managed funds? ›
Index funds give you less control than other types of investments. The investment return and principal value of an index fund will fluctuate. Index funds will be subject to the same special risks as the securities making up the index.
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.
What are the disadvantages of actively managed certificates? ›
One of the main drawbacks is the higher fees and expenses. 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.
What percentage of ETFs are actively managed? ›
Exchange-traded funds used to be synonymous with passive investing. But since the beginning of 2019, actively managed ETFs' share of the US ETF market has more than quadrupled—from just over 2.0% to 8.5% as of March 31, 2024.
Why do people invest in actively managed funds? ›
Among the benefits they see: Flexibility – because active managers, unlike passive ones, are not required to hold specific stocks or bonds. Hedging – the ability to use short sales, put options, and other strategies to insure against losses.
Do actively managed ETFs distribute capital gains? ›
Both mutual funds and ETFs are required to distribute capital gains and income to investors at least annually.
What is one advantage of an ETF compared to an actively managed fund? ›
ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds. And, in general, ETFs tend to be more tax efficient than index mutual funds.
What are the disadvantages of active funds? ›
Cons
- there's no guarantee an active fund will perform better than the index – in fact, research shows that relatively few active funds do.
- it's not enough to just beat the index – active funds have to beat it by at least enough to cover their expenses, such as transaction fees.
Disadvantages of investing in FOFs
Investors might face the fees associated with the FOF itself and the fees of the underlying funds within the portfolio. These cumulative expenses can eat into overall returns, potentially reducing the net gains for investors.
Why do actively managed funds underperform? ›
Another driver of the underperformance of active funds, according to McDermott, is fees: “All funds have years where they underperform, however, the longer-term evidence is undeniable that active managers have continued to struggle. The main reason for this underperformance is because active funds charge higher fees.”
What is the benefit of actively managed funds? ›
Investing in one or more actively managed funds can help with diversification. That's important for managing risk and again, an active fund manager may be in a better position to hedge against potential volatility compared to funds that take a passive approach and simply track an index.
