If you dabble in ETF investments you’re going to hear more and more about actively managed ETFs in the coming years. But what are they and are they smart investments? Let’s take a look under the hood and find out.
ETFs and Actively Managed ETFs
Just to refresh your memory, ETF stands for Exchange Traded Fund. Traditionally, these are index assets; pooled funds that buy and hold stocks that make up an index. Original recipe ETFs (passive funds) are very similar to index mutual funds. The main difference is that the ETF trades like a stock so you can buy and sell during the day and know the buy and sell prices real time. With mutual funds, you have to wait until the close of business to get your pricing information.
Actively managed ETFs are also pooled assets like mutual funds and they also trade during the day like traditional ETFs. But unlike old school ETFs, actively managed ETFs don’t just buy securities that make up an index. Like actively managed mutual funds, actively managed ETFs buy and sell stocks at the discretion of the manager. That means they need to spend more time and money on trading. More on this in a minute.
Why Do Actively Managed ETFs exist?
The big attraction towards passive ETFs has always been the low-cost, high liquidity and good performance that accompanied buying and holding the index. But actively managed ETFs are more hands-on as I said. There is a lot a lot more trading going on with active ETFs which requires spending more money to build a management team and infrastructure.
Someone has to pay for this of course. And that someone is you. Active ETFs often have higher when compared with the passive ETFs. These of course are all negatives. But the financial service industry created actively managed ETFs despite these drawbacks. They did so because they hoped to make up for those shortfalls (and then some) by outperforming their slower-moving traditional peers.
The concept was if they do earn higher returns, more investment dollars would flow into these funds. Of course if that happens, the companies earn even more fees – which is the reason they exist in the first place.
Do Actively Managed ETFs Deliver?
Yes and no. Some actively managed ETFs do outperform over a given time period and others don’t. This is very similar to the mutual fund situation. Some actively managed funds serve up outsized returns too – for a while – while others languish.
My experience tells me that picking the right investment vehicle. (Active, passive, ETF, mutual fund) is important, but it’s only a small part of your investment success. What’s far more important, again in my experience, is the manner in which you invest; the process you use to select the specific fund, when to buy it and when to sell it.
Actively Managed ETF Special Warnings
Some of these puppies do have an edge but make sure you know what it is. In order to know that, you have to ask lots of questions.
Generally speaking, the broad indexes are really hard to beat so you might look towards other more esoteric indexes if you are interested in actively managed ETFs. This would be in the international, small cap and specialty bond sectors.
But if you do stick your toes in the water, be careful. The average actively managed ETF is only 1 ½ years old and only manages a small investment base.
Make sure the fund you are thinking of purchasing has significant assets. If it doesn’t you may find yourself with a semi-illiquid investment and that could cost you money when it’s time to buy or sell.
Some people view the introduction of active ETFs as a good thing. For me, it’s rather ho hum. But part of me sees this as just another way for the industry to inject something new into the market in order to capture the interest of investors. I liken it to the soft drink industry introducing a “new” drink that really isn’t that new.
If you are a buy and hold investor, actively managed funds probably should stay off your radar. And if you are performance based investor, these newbie options will show up on your list if their performance delivers. In either case, I wouldn’t go out of my way to sink money into these investments – but I wouldn’t avoid them if a specific fund makes the grade.
Are you investing in actively managed ETFs? Why or why not?