Active ETFs Explained

Most people automatically think about passive funds when discussing exchange-traded funds (ETFs). It is easy to forget that these funds – which are so popular among small investors – can also be actively managed. This moneyland.ch guide brings together the most important information on the topic of ETFs with active fund management.

What is an active ETF?

The term active ETF denotes an ETF that does not track an existing market index. Instead, it uses a portfolio that is actively put together and maintained by fund managers. The principle is the same as that used by actively managed mutual funds in that the portfolio is adjusted and optimized on an ongoing basis in keeping with the fund’s investment strategy. The only difference between active ETFs and active mutual funds is that ETFs are listed and traded on stock exchanges.

The concept of an actively managed ETF may seem contradictory at first glance, because ETFs are universally associated with passive investments. But although the overwhelming majority of ETFs are passively managed funds that replicate market indexes, ETFs do not necessarily have to be passive funds (unlike index funds). The only common denominator between all ETFs is that they are publicly listed and traded on stock exchanges.

According to data from US bank JP Morgan, active ETFs made up around 2 percent of the overall EU-regulated ETF market in 2023, and the trend is growing.

What is the goal of an active ETF?

Like all actively managed investment funds, active ETFs aim to outperform the overall market. Fund managers actively select the assets to invest in, and choose the weighting of each asset in the fund’s portfolio. An asset can be given higher or lower priority based on its performance, or it can be removed from the portfolio altogether.

Active ETFs can also invest in asset classes for which there are no established market indexes.

How are active ETFs different from other active investment funds?

A key difference between active ETFs and active mutual funds is that an exchange-traded fund, as its title suggests, is traded on a public stock exchange. That normally is not the case with other kinds of actively managed investment funds. Investors can buy and sell ETF shares at any time during trading hours – regardless of whether the ETF is active or passive.

Actively managed ETFs also differ from conventional active mutual funds on some other points:

• Lower costs: Compared to other active investment funds, active ETFs often have lower fund fees (shown as the TER). Most active ETFs have TERs below 1 percent. Active mutual funds may have TERs that are much higher than that. It is important to note, though, that there is no hard and fast rule. Some active ETFs have higher fees than some active mutual funds.
• More Transparent: Because ETFs are listed on public stock exchanges, they are subject to stricter information-sharing requirements than other active funds. Many mutual funds do not publish daily updates about their composition and investment criteria. Compared to conventional funds, ETFs are more transparent.
• Easy to trade: Whether passive or active, ETFs are widely available. You can buy or sell shares in an ETF at any time during trading hours using any stock broker that trades on the exchange in question. You do not need to work through a bank or other service provider that partners with the fund. It is important to note, though, that some brokers may not give you access to all of the ETFs listed on an available stock exchange.

What are the disadvantages and risks of active ETFs?

The main disadvantage of active ETFs is that they generally have higher fees than passive ETFs. Many passive ETFs that simply replicate an underlying market index have TERs lower than 0.2 percent. Some have TERs below 0.1 percent. ETFs that are actively managed generally cannot compete in terms of pricing. Many have TERs higher than 0.5 percent. High ongoing investment costs have a negative impact on returns.

There is no across-the-board answer for whether active ETFs perform better than passive ETFs. Numerous studies have shown that many active investment funds have not been able to outperform the market over long terms. Whether or not an active ETF performs better than a passive ETF primarily depends on the makeup of the fund’s portfolio or underlying market index. These can be thoroughly or poorly diversified depending on the investment theme.

However, the table below shows that active ETFs can potentially deliver better performance than their passive equivalents, even over a mid-length investment term. Both the Invesco Quantitative Strategies ESG Global Equity Multi-Factor UCITS ETF Acc and the JPMorgan Global Research Enhanced Index Equity (ESG) UCITS ETF USD (acc) have had better performance over the past five years than the MSCI World global index. Both of these active ETFs invest in large companies across industrialized nations, so they are very similar to passive global ETFs.

Performance comparison between two active global ETFs and one passive global ETF

Source: Justetf.com. Dates for performance comparison: 30.10.2019 and 30.10.2024. Returns in CHF including dividends.

It is important to note, however, that past price developments are not a sure indicator of future returns. Performance figures can vary depending on which timeframe you use. As a general rule, investments in the stock market should use terms longer than five years.

Note: This article is provided for educational purposes only and should not be considered investment advice. The publishers do not accept any liability in connection with this article.

More on this topic:
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Checklist for choosing the right ETF
The difference between active and passive funds