Actively managed ETFs were first launched in the U.S. in 2008 offering benefits previously unavailable to investors. But their popularity remained limited until 2019 due to portfolio disclosure requirements favoring mutual funds as the preferred vehicle for active management.
However, an announcement by the Securities and Exchange Commission in November 2019 permitting new types of active ETFs (known as semi-transparent ETFs, non-transparent ETFs or Active Non-Transparent “ANT ETFs“) sparked renewed interest and has accelerated the growth of active ETFs ever since.
In this article, we highlight the benefits and limitations of actively managed ETFs vs mutual funds, followed by a discussion of the evolving industry landscape. We then preview forthcoming innovations to active ETFs that stand to disrupt the status quo of active management and level the playing field vs passive investments.
What are Actively Managed ETFs?
Actively managed ETFs are exchange-traded funds that invest in securities like stocks and bonds chosen by the fund’s manager rather than passively following an index or a rules-based strategy. Often, actively managed ETFs are simply referred to as active ETFs.
As with actively managed mutual funds, the performance of an active ETF is dependent upon the investment selection of the manager whose goal is to outperform a market benchmark. The lower cost of active ETFs increases the likelihood of achieving this goal by reducing the investment returns required by the fund manager.
Key Considerations Before Investing in Active ETFs
Before diving into any ETF—whether actively managed or otherwise—it’s important to take a close look at the fund’s investment objectives, its specific risks, as well as the charges and expenses involved. Investors should review the prospectus or summary prospectus provided by the fund company, which lays out details about the fund’s strategy, its costs (such as management fees and expense ratios), and the risks associated with its holdings or investment focus.
Understanding these elements can help you determine whether an ETF aligns with your financial goals, risk tolerance, and investment horizon. Always be sure to carefully read all available materials, and consider consulting with a financial professional if you have questions about how a particular ETF fits within your broader portfolio.
Diversification, Asset Allocation, and Their Role in ETFs
When considering active ETFs, it’s important to understand how diversification and asset allocation come into play. ETFs—whether actively managed or not—often provide instant diversification by pooling investors’ money to purchase a wide selection of securities within a single fund. This diversification can help reduce the impact of any single stock or bond on your overall returns, spreading risk across multiple holdings.
Asset allocation, on the other hand, refers to how investments are distributed among different asset classes, such as stocks, bonds, or alternatives. The choices a fund manager makes regarding asset allocation are central to the fund’s strategy and risk profile, aiming to balance potential returns with an acceptable level of risk. While diversification and asset allocation are essential tools in managing investment risk, it’s important to note that they do not eliminate the possibility of loss or guarantee a specific outcome. Rather, they serve as part of a broader approach to building a resilient investment portfolio.
Benefits of Active ETFs vs Mutual Funds
There are a number of potential benefits offered by active ETFs relative to actively managed mutual funds. Four of the most meaningful benefits include lower costs, tax-efficiency, an ability to buy and sell during market hours and additional trading flexibility.
Lower Cost and Higher Return Potential
Active ETFs combine lower costs with the potential for higher returns than an actively managed mutual fund with a similar investment process and portfolio due to inherent cost advantages of exchange-traded funds.
While generally more expensive than passive ETFs and index funds, the elimination of sales charges that compensate financial advisors and operational expenses for large shareholder servicing departments results in the potential for active ETFs to be priced much cheaper than an actively managed mutual fund equivalent. Further, the elimination of trading commissions on ETFs across most discount brokerage firms offers a significant benefit to do it yourself (DIY investors).
This lower cost helps fund managers improve net investment returns to investors that would otherwise be lost to operational expenses, brokerage commissions or paid to financial advisors.
Improved Tax-Efficiency
Active ETFs offer the opportunity for improved tax-efficiency similar to passive ETFs, benefiting from attributes of exchange-traded funds not available in traditional mutual funds. Because investors can buy and sell ETF shares on a stock exchange just like stocks, portfolio managers do not have to raise cash when there is enough marketplace liquidity to fill sell orders.
In the case of large orders, market makers known as authorized participants can create or redeem ‘creation units’ in exchange for a basket of securities held by the ETF. This in-kind creation and redemption process avoids the sale of securities and hence capital gains taxation.
Buy and Sell when the Stock Exchange is Open
Investors can buy and sell shares in active ETFs during the trading day while the stock exchange is open, unlike an actively managed mutual fund which is generally priced only once each day after the market close.
While an advantage of a mutual fund’s pricing structure is an assurance that shares will be transacted at the fund’s net asset value (NAV), a disadvantage is that investors will not know the NAV at any point during the trading day and will only learn the NAV after the market close.
Use Margin or Sell Short
Active ETFs can be traded beyond just buying and selling shares outright; The exchange-traded structure of ETFs allows the shares to be sold short and also allows for the use of margin when purchasing shares, options not available for traditional active (or passive) mutual funds.
Leveraging Online Tools and ETF Screeners
Investors looking to compare active ETFs and determine which products best fit their objectives have a host of online resources at their disposal. Third-party research platforms such as Morningstar, ETF.com, and Bloomberg offer powerful ETF screeners that allow users to filter funds by strategy, cost, sector exposure, historical performance, and risk metrics.
With these tools, you can:
Filter ETFs by category, expense ratio, issuer, and underlying holdings to hone in on funds that match your risk tolerance and goals.
Access comprehensive data on long-term performance, fees, distributions, liquidity, and portfolio composition.
Compare multiple ETFs side by side to weigh critical factors such as tracking error, active share, and trading spreads.
Read analyst research, ratings, and investor reviews for further insight into fund strategy and management quality.
By taking advantage of these resources, investors gain a clearer picture of available options and are better equipped to make informed decisions, whether seeking to complement existing portfolios or simply learning more about how active ETFs operate in different market environments.
Active ETF Limitations and Industry Headwinds
While active ETFs offer many potential benefits, investors should consider structural limitations that may result in an actively managed mutual fund or other investment vehicle being preferable to active ETFs.
Share Price Deviation from Net Asset Value
On days when market and trading volatility is higher than normal, active ETFs might experience a relatively large spread between the market price of the fund and the fund’s net asset value (NAV) known as a discount or premium.
A discount to NAV means that the fund is trading at a lower share price than the per share value of the ETF’s underlying holdings. If the ETF is traded at a premium, this means the share price is higher than the combined value of the fund’s holdings on a per share basis.
To minimize the frequency and magnitude of ETF shares trading at a premium or discount to NAV, authorized participants play a valuable role stepping in to execute trades intended to bring an ETF’s share price back in line with its NAV.
Portfolio Transparency
Regulations requiring daily disclosure of portfolio holdings in active ETFs preserved the status of mutual funds as the preferred vehicle for active management through 2019. Unlike passive investments in ETFs and mutual funds where portfolio transparency inherently reflects the holdings of the index being tracked, actively managed mutual funds are permitted to disclose holdings much less frequently to protect the fund manager’s intellectual capital and mitigate unscrupulous trading activity.
Until 2019, the Securities and Exchange Commission (SEC) treated actively managed ETFs just like passive ETFs, limiting active ETF product development to strategies least affected by daily transparency requirements. However, a long-awaited announcement by the Securities and Exchange Commission (SEC) in November 2019 approving new types of active ETFs known as semi-transparent ETFs or non-transparent ETFs is rapidly leveling the playing field as we discuss below.
Investing in International Equities and Low Liquidity Sectors
While additional regulatory relief from the SEC for semi-transparent and non-transparent ETFs in the future may alleviate the issue, existing portfolio disclosure requirements and efforts to minimize deviation of an ETF’s share price from its NAV restricts active ETF from investments in international equities traded on a foreign exchange and creates challenges investing in certain areas like small cap stocks.
For example, a stock that trades on a foreign exchange, in a different time zone, results in times when the market on which the active ETF is listed is open but the market on which the underlying stock is listed is closed.
Risks of Investing in Fixed Income ETFs
Active ETFs that focus on fixed income securities—like those tracking government or corporate bonds—come with their own set of considerations. Chief among these are the classic perils of bond investing:
Interest Rate Risk: When interest rates climb, bond prices generally drop, and vice versa. This means that the value of a fixed income ETF can fluctuate with rate changes in the broader market.
Credit and Default Risk: The risk that the issuer of a bond might not meet its payment obligations (default risk) or may see its credit quality decline (credit risk), both of which can impact the ETF’s value.
Inflation Risk: Rising inflation can erode the real value of returns from fixed income investments, making them less attractive during inflationary periods.
Call Risk: Some bonds may be “called” or redeemed before maturity by the issuer, usually when interest rates fall, affecting the consistency of returns.
Unlike holding an individual bond to maturity (which can help insulate investors from price swings), fixed income ETFs typically do not have a fixed maturity date. This means you’re exposed to ongoing market price changes and may need to accept volatility if you need to sell your investment before any bonds naturally roll off within the ETF.
Additionally, certain fixed income ETFs invest in lower-rated, higher-yield bonds—which, while potentially more rewarding, carry a greater likelihood of significant price movements or even default if the issuer encounters financial trouble.
With these factors in mind, it’s important to weigh the blend of risks and potential rewards when considering fixed income ETFs as part of your portfolio.
Similarities and Differences: Active ETFs vs Mutual Funds vs Passive ETFs
Active ETFs combine the potential benefits of active management traditionally offered through mutual funds with the lower cost and tax-efficiency of ETFs, popularized in recent years primarily through passive ETFs. This table provides a comparison of product attributes for active ETFs vs active mutual funds and passive ETFs.
Attribute | Active ETFs | Active Mutual Funds | Passive ETFs |
Seeks to outperform the market or its benchmark | Yes | Yes | No |
Relies on the active security selection of a fund manager | Yes | Yes | No |
Tracks an index or popular benchmark | No | No | Yes |
Trades on one or more stock exchanges | Yes | No | Yes |
Can be sold short | Yes | No | Yes |
Can be purchased on margin | Yes | No | Yes |
Tax-efficient structure | Yes | No | Yes |
Relative cost (typical) | Moderate | Highest | Lowest |
The Early Years of Active ETFs (2008 – 2019): Stuck in the Shadows as Passive ETFs Flourished
For more than 10 years following launch of the first actively managed ETFs in 2008, asset growth in active ETFs remained muted. This was primarily due to regulatory requirements that portfolio holdings be disclosed daily, unlike actively managed mutual funds permitted by the SEC to only disclose holdings on a monthly or quarterly basis.
While daily transparency of portfolio holdings isn’t a significant issue for an index tracking ETF, this disclosure can be a disadvantage for active managers and potentially detrimental to fund performance.
One reason why active managers are concerned about disclosing their portfolio holdings daily is the potential for front-running by traders. Front-running involves buying or selling a stock based on knowledge of a portfolio manager’s ongoing investing activity that results in potential profits to the trader instead of investors in the actively managed fund or ETF.
Another concern among active managers regarding daily portfolio holding transparency is the ability for the active fund to be easily replicated by competitors or investors. One portfolio manager summed up how he feels about managing an actively managed fund with real-time disclosure of portfolio holdings by saying: “I don’t like performing stark naked in Times Square.”
One portfolio manager summed up how he feels about managing an actively managed fund with real-time disclosure of portfolio holdings by saying: “I don’t like performing stark naked in Times Square.”
To combat these concerns, industry stakeholders like Precidian Investments began to petition the SEC for regulatory relief to put active ETFs on a more even playing field with actively managed mutual funds. During this time, a handful of asset managers launched active ETFs primarily investing in fixed income securities where front-running and portfolio replication concerns were limited.
The most successful active ETF launched during this period based on assets under management at the end of 2019 was the PIMCO Enhanced Short Maturity Active Exchange-Traded Fund (ticker symbol: MINT) launched in November 2009. Five of the ten largest active ETFs at the end of 2019 were in the ultra-short bond category, with three others also in the bond space. None of the top ten invest in a core domestic or international equity asset class.
With $56 billion in assets among the top 10 active ETFs compared to $1.2 trillion in assets among the top 10 passive ETFs at the end of 2019, some industry observers have considered this period a golden decade for passive investing.
But an announcement by the SEC in November 2019 led many industry observers to believe the dominance of passive ETFs could wane with actively managed ETFs positioned for rapid growth.
The Roaring ‘20s for Active ETFs: Introducing Non-Transparent ETFs (ANT ETFs) and Semi-Transparent ETFs
On November 14, 2019, the SEC publicly announced its intention to approve new and innovative ETF structures that permit actively-managed ETFs to not publish their holdings each day. These new types of ETFs are commonly referred to as semi-transparent ETFs or non-transparent ETFs (also abbreviated as ANT ETFs).
This announcement was welcomed by many of the largest asset managers and stock exchanges in the U.S. who had presented numerous proposals to the SEC over several years seeking relief to launch actively managed ETFs that preserve the cornerstone feature of actively managed mutual funds – delayed disclosure of portfolio holdings.
While mechanical differences exist among the new active ETF structures approved by the SEC, common features include the ability for fund managers to delay full portfolio disclosure by at least 30 days following the end of each month. Additionally, each structure requires enhanced board oversight intended to ensure market prices for ETFs trade in line with the underlying portfolio net asset value.
An additional condition of the SEC’s approval of semi-transparent and ANT ETFs limits potential investments to securities that trade on an exchange with the same operating hours as the ETF itself. This is intended to reduce the risk of an ETF’s share price deviating significantly from its NAV in situations where a security traded on a foreign exchange is closed while the U.S. markets remain open and subject to price fluctuations. While this condition may be revisited by the SEC in the future, actively managed ETFs seeking foreign exposure will be limited to investments in American Depository Receipts (ADRs).
Investors can expect to see many new semi-transparent ETFs and ANT ETFs launched in 2020, especially among traditional managers of actively managed mutual funds. It remains to be seen if most of these new active ETFs will replicate existing actively managed mutual funds or pursue new investment strategies.
Asset managers will also weigh the merits of converting actively managed mutual funds entirely to an active ETF, an action that requires careful consideration and the approval of multiple stakeholders.
The Bottom Line
While asset growth in actively managed ETFs was limited through 2019 primarily due to regulatory constraints and investor appetite for passive investing, the 2020s could represent a golden era for active ETFs and their issuers.
Traditional active managers converting mutual funds or expanding their lineup to include lower cost and more tax efficient active ETFs will remove a major impediment that helped tilt flows towards index funds and passive ETFs in recent years.
The success of active management remains contingent upon a fund manager’s ability to outperform its benchmark. Active ETFs help issuers improve their odds through reduced costs that lower the investment returns required for a fund manager to achieve this goal.
Resources for Expanding Your ETF Knowledge
Looking to enhance your understanding of ETFs and refine your investment strategy? There’s no shortage of top-tier educational tools and research platforms available.
Industry Insights & Market Analysis: Stay informed with resources like Morningstar (https://www.morningstar.com/), ETF.com (https://www.etf.com/), and Bloomberg (https://www.bloomberg.com/markets/etfs), which offer in-depth analysis, news, and commentary on ETF trends, performance, and evolving investment themes.
ETF Screeners and Comparison Tools: Take advantage of robust screeners from reputable outlets such as ETF Database (https://etfdb.com/screener/), Yahoo! Finance ETF Screener (https://finance.yahoo.com/screener/etf_new), and NerdWallet’s ETF tool (https://www.nerdwallet.com/investing/etfs). These allow investors to filter choices based on specific criteria—including sectors, geographic exposure, and expense ratios—to find ETFs that align with their objectives.
Educational Resources and Learning Hubs: For those wanting to dig deeper, consider visiting educational centers maintained by organizations such as Investopedia (https://www.investopedia.com/etf-4427785), the CFA Institute (https://www.cfainstitute.org/en/research/foundation/2019/etfs-what-you-need-to-know), or Bogleheads® Wiki (https://www.bogleheads.org/wiki/Exchange-traded_fund). These offer everything from beginner articles to advanced tutorials on ETF mechanics, tax implications, and portfolio construction.
Whether you’re just starting out or refining a seasoned strategy, these resources provide valuable knowledge to help guide well-informed ETF investment decisions.
Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. Before making major financial decisions, please speak with us or another qualified professional for guidance. The original version of this article first appeared on Wealthtender written by Brian Thorp.