ETFs are traded on stock exchanges while the market is open. Unlike mutual funds, the value of an ETF fluctuates throughout the day in accordance with the value of its holdings, rather than adopting the net asset value (NAV) calculation used by mutual funds at the end of each business day. While passively managed ETFs track a benchmark such as the S&P 500 or the Nasdaq 100, the concept behind an actively managed ETF is that the fund manager(s) can deviate from a benchmark when selecting the fund’s holdings in an attempt to beat a benchmark’s performance.
Example of an Actively Managed ETF
One example of an actively managed ETF is the ARK Innovation ETF (ARKK). This fund, which is managed by a team led by Cathie Wood, has been in the news in the past in part because of significant swings in its performance. The fund prospectus states its objective is to seek long-term growth of capital by investing at least 65% of its assets in shares of companies that it feels are relevant to its theme of “disruptive innovation.” The ARK ETF website reported that year to date through Aug. 31, 2022, the value of the ETF dropped 55.72%. During that same time, the S&P 500 dropped about 17%. In 2020, a year in which the fund’s predominantly high-tech holdings performed well, the ARK fund returned more than 152% while the S&P 500 returned just 16%. The ETF fund manager or management team of an actively managed fund purchases and sells assets based on their own research rather than tracking a specific index. Many ETFs will make their holdings public every day in addition to the quarterly disclosure required by the Securities and Exchange Commission (SEC). Typically, there are more passively managed ETFs than actively managed ones for you to choose from when looking to invest. And it’s important to be mindful that actively managed ETFs usually have higher costs.
Types of Actively Managed ETFs
There are two types of actively managed ETFs: traditional and semi-transparent active equity ETFs. Semi-transparent active equity ETFs were approved by the SEC in 2019. The name refers to the rule that says fund managers do not have to disclose the fund’s full holdings daily in order to avoid having other traders “front-run” their trades. Standard ETFs make trades through an authorized participant (AP)—licensed broker dealers—that facilitate the trade on behalf of the ETF. In semi-transparent active equity ETFs, an authorized participant representative (APR) facilitates the trade on behalf of the AP within a confidential account, and delivers those shares to the ETF manager. Charles Schwab states on its website that “based on their limited track records so far, semi-transparent ETFs appear to be trading in line with other ETFs in the same asset class and with similar fund sizes.” It also says that “the range of investment strategies employed by active semi-transparent ETFs is limited (at least initially), as the securities eligible for inclusion must be U.S. exchange-listed and trade during U.S. market hours.”
Alternatives to Actively Managed ETFs
Alternatives to actively managed ETFs include passively managed ETFs, as well as actively managed mutual funds or low-cost index mutual funds. Actively managed funds, whether they are ETFs or mutual funds, often come with higher fees and administration costs. In addition, there is no strong evidence that actively managed ETFs consistently outperform index funds or passively managed ETFs. In fact, the opposite tends to be true.
Pros and Cons of Actively Managed ETFs
Pros Explained
Intraday trading: ETFs offer intraday trading capabilities, while mutual funds trade at the end of each business day based on the fund’s NAV.Goal is to outperform indexes: A main selling point of actively managed ETFs is that managers will use their research in an attempt to outperform benchmarks.May cost less than actively managed mutual funds: The structure of an ETF allows some to have lower costs than actively managed mutual funds.
Cons Explained
Fewer actively managed ETFs to invest in: Passively managed ETFs far outnumber actively managed ETFs, making it easier for you to find a passive one to invest in.History shows a low percentage actually outperform index funds with comparable investment strategies: Research by Vanguard and other investment firms show that a majority of actively managed ETFs fail to outperform the benchmark they seek to beat.Typically higher fees than passively managed ETFs: Passively managed ETFs and index funds typically have lower fees than an ETF that is actively managed.
Limitations of Actively Managed ETFs
Actively managed ETFs may have higher costs associated with them, such as higher expense ratios. That can eat into your investment profits. Additionally, history has shown that actively managed ETFs do not often outperform other funds, an index, or benchmark. ETFs that are actively managed may not be right for those investors who really value diversification, too. Lastly, they may be harder to come by. If you’re looking to invest in an ETF, a passively managed ETF may be easier and cheaper.
What It Means for Investors
Some investors may prefer an actively managed ETF that aims to outperform its benchmark. As with assessment of mutual funds, however, it is important to focus on long-term performance. An actively managed ETF may outperform its benchmark significantly, only to drastically underperform in a down market due to higher risk. If you’re interested in an actively managed ETF, you may want to counterbalance it by including some passively managed ETFs or mutual funds in your portfolio.
