Investors weren’t ready for actively managed exchange-traded funds (ETFs) back in 2008, when the first one launched. That ETF, a short-term bond strategy called Bear Stearns Current Yield, closed before its first-year anniversary as the financial crisis was unfolding, without having attracted much money. Times have changed. Active ETFs, through which managers target individual stocks instead of broader indexes, are pulling in billions these days.
Over the past 12 months through the end of March, actively managed ETFs have garnered $157 billion, or 22% of all net ETF inflows (the sum of money deposited minus money that’s withdrawn). A decade ago, active ETF strategies claimed just 2% of all net inflows, says Aniket Ullal, head of ETF data and analytics for investment research firm CFRA Research, with the bulk of assets going into far more popular index-tracking ETFs.
The embrace of active ETFs is reflected in a surge of both demand and supply. Many advisers now prefer ETFs to mutual funds because ETFs tend to be more tax efficient. And advisers want access to ETFs that employ the same active mutual fund strategies they use in client portfolios. Mutual fund firms are now meeting those demands.
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“After many years of ETFs pulling in more money than mutual funds, the big fund companies have had to enter the ETF space,” says Ullal.
That partly explains the accelerated pace of new active ETF launches: Of the 327 actively managed diversified stock ETFs in the U.S. today, almost half were launched over the past two years.
We took a closer look at the offerings in U.S. diversified stock funds to find the best new active ETFs available today. The funds we highlight below are diversified; none are sector funds or so-called thematic funds that invest in a particular trend, such as clean energy or artificial intelligence. All returns and data are through March 31.
Avantis
The folks at Avantis have a specific definition of value. “We want good prices but also good profits. We target that intersection,” says Phil McInnis, the firm’s chief investment strategist. Profitability and a low price, he adds, are “good proxies” for expected return rates.
So far, so good. Since its September 2021 launch, the Avantis U.S. Large Cap Value ETF (AVLV) has returned 12.5% annualized, outpacing the S&P 500 index and the lion’s share of the ETF’s peers (funds that focus on bargain-priced large-company stocks). Top holdings in the large-cap value fund, which charges a 0.15% expense ratio, include Meta Platforms (META), JPMorgan Chase (JPM) and Costco Wholesale (COST).
Despite the big run-up in Meta shares, the stock “still ranks high on value and profitability. It doesn’t get the highest ranking on those measures, but it’s a big company and we factor in market cap to determine weight in the portfolio,” says McInnis.
Avantis U.S. Small Cap Value ETF (AVUV) launched in September 2019 and has a longer track record that’s equally bright. The small-company value fund, which charges a 0.25% annual expense ratio, has returned 11.0% annualized over the past three years. That’s better than 91% of its peers (funds that focus on small, value-priced companies). It also beat the 0.1% annualized loss in the Russell 2000, an index of small-cap stocks.
At last report, the top three stocks in the fund were wood-products and materials maker Boise Cascade (BCC), retailer Abercrombie & Fitch (ANF) and SM Energy (SM).
Capital Group
Capital Group is the firm behind the well-regarded American Funds suite of mutual funds, which have been sold mostly through advisers. With the 2022 launch of active ETFs, however, the firm’s strategies are now available to any investor.
Like the mutual funds, the ETFs are managed in the Capital System way – in which multiple managers divide a fund’s assets and run each sleeve independently. But the Capital Group ETFs are not clones of existing American Funds products.
The Capital Group Core Equity ETF (CGUS) aims for long-term growth of capital and income. The fund’s six managers can invest in companies of any size, but the portfolio holds mostly large-company stocks, a mix of fast growers and blue chip dividend payers. Microsoft (MSFT), Amazon.com (AMZN), Broadcom (AVGO) and GE Aerospace (GE) are among the fund’s top five holdings.
“The goal is to offer a smoother ride for investors,” says Zahid Nakhooda, an ETF specialist with Capital Group. Since its inception in February 2022, Core Equity has returned 13.3% annualized, better than the 11.8% average annual gain in the S&P 500. Its expense ratio is 0.33%.
The Capital Group Growth ETF (CGGR) and the Capital Group Dividend Value ETF (CGDV) are often paired together in a portfolio, says Nakhooda. Over the past two years, a 50-50 combination of the Growth and Dividend Value ETFs has returned 12.2% annualized, beating the S&P 500 by an average of nearly three percentage points per year.
The Growth fund holds, not surprisingly, some of the market’s best performers of late, including Meta Platforms and Netflix (NFLX), but Regeneron Pharmaceuticals (REGN), Visa (V) and Intuitive Surgical (ISRG) are also among the top 10 holdings.
Top holdings at Dividend Value include Microsoft, British American Tobacco (BTI), Carrier Global (CARR) and Broadcom. The Growth ETF has a 0.39% expense ratio; Dividend Value, 0.33%.
Fidelity
The Fidelity Enhanced Large Cap Core ETF (FELC) is designed to serve as a core holding in a portfolio – much like an index fund. But it aims to beat its underlying benchmark, the S&P 500, with less risk by using a proprietary quantitative model. Over the past three and five years, Fidelity Enhanced Large Cap Core has beaten its benchmark on an annualized-return basis, with less volatility. The fund charges a 0.18% expense ratio.
Computers drive the stock picking, employing machine learning and natural language processing, for instance, but it isn’t a “black box,” says Mike Hagopian, a portfolio specialist who works closely with the firm’s Enhanced suite of funds. The model focuses on the usual fundamental stock measures, such as valuation, growth and quality, but it also homes in on atypical measures, such as spending on research and development, intellectual property assets and what current activity in the options market says about a particular company’s shares.
The aim is to find reasonably priced shares in a company with strong prospects, growing earnings and a stock price with upward momentum, all relative to peers.
“There isn’t a singular characteristic or factor that defines our favorites,” says Hagopian, “but we look at the overall picture.”
Putnam Investments
Only 44 stocks fill the Putnam Focused Large Cap Value ETF’s (PVAL) portfolio, and that’s by design. “We want to own the best stocks within each sector,” says Lauren DeMore, who comanages the fund with Darren Jaroch. They favor companies with strong cash flows and the ability generate and increase dividends for investors, but DeMore is quick to add that there isn’t “one sound bite or even a few bullet points” that characterize stocks in the portfolio.
The managers recently added to their stake in Citigroup (C). Shares in the financial services company typically trade at a discount relative to peers because historically it has underperformed. But Citi chief Jane Fraser is working to improve the company’s profitability, in part by reducing expenses. “That’s what we’re playing for,” says DeMore.
The fund’s secret sauce is the managers’ “maniacal attention” to risk, says DeMore. They take their time building the portfolio. “We own stocks for an average of five years, and it takes us about an average of six months to become comfortable adding a new name to the fund,” says DeMore. Insurance giant American International Group (AIG), Exxon Mobil (XOM), and investment firm Apollo Asset Management (APO) were top holdings at last report.
The ETF opened in May 2021, though it’s worth mentioning that the managers have been running the strategy as a separately managed account since 2016. Since the ETF launched, its 14.5% annualized return has beaten the 10% gain in the S&P 500.
“We aim to be consistently good, not occasionally great,” says DeMore. The ETF charges 0.56% in expenses.
Mutual fund lookalikes
It isn’t unusual these days to find an exchange-traded fund version of a standout active mutual fund strategy. In fact, two members of the Kiplinger 25, the list of our favorite no-load mutual funds – the Fidelity Blue Chip Growth and T. Rowe Price Dividend Growth – are also available as ETFs, run by the same skilled managers. Their ticker symbols are FBGC and TDVG, respectively.
But the ETFs aren’t exact clones of the mutual funds. They can’t be, in part, because the mutual funds have greater latitude to invest in certain securities than the ETFs, such as stakes in companies that haven’t gone public yet. For example, Fidelity’s Sonu Kalra, who runs the Blue Chip Growth mutual fund and ETF, owns a stake in the private company Space Exploration Technologies, better known as Elon Musk‘s SpaceX, in the mutual fund but not in the ETF.
But ETF replicas are worth considering. The ETFs boast slightly lower expense ratios, for a start, compared with their mutual fund counterparts. Plus, there’s no minimum to buy ETF shares at most brokerage firms. (Fidelity has no minimum investment required for its mutual funds, but T. Rowe Price funds have a minimum initial investment of $2,500.)
Finally, the long(ish)-term returns are similar. Over the past three years, returns for the ETF and mutual fund versions of Fidelity Blue Chip Growth are the same: 9.7% annualized.
We’re carefully watching this trend of good active mutual funds opening ETF siblings. One new offering in particular has caught our eye: The T. Rowe Price Capital Appreciation Equity ETF (TCAF).
The ETF gives you access to the prowess of David Giroux, a star manager whose highly rated stock-and-bond mutual fund, T. Rowe Price Capital Appreciation, is closed to new investors. The ETF holds only stocks – almost 100 securities, which is more than the 40 to 60 names typically found in the balanced mutual fund, says a Price spokeswoman. But both leverage the fundamental, bottom-up investment approach of the firm’s extensive research team (and Giroux, of course).
Active ETFs give investors a tax-friendly option
Tax efficiency has been a big draw for ETF investors. The advantage comes from the way ETF shares are created and redeemed. Mutual funds must sometimes sell underlying securities to meet shareholder redemptions. That can trigger a capital gains distribution, which is shared by all fund shareholders. (Mutual funds are required by law to pay out any realized gains to shareholders at least once a year.)
ETFs, on the other hand, don’t actually buy and sell the underlying securities in their portfolios. Instead, the ETFs hand over baskets of securities to third parties – institutional investors and market makers called authorized participants – for redemptions when shareholders in the fund sell shares; or the ETFs receive baskets of securities when shareholders buy shares and new shares must be created.
No cash changes hands between the ETF and the authorized participants during these so-called in-kind transactions, and because of that, the ETF isn’t as likely as a mutual fund to make a capital gains distribution. (You’re still liable for capital gains taxes when you sell shares.)
According to an October 2023 study by T. Rowe Price, 47% of mutual funds, on average, distributed capital gains to their shareholders during the five-year period from the start of 2018 through 2022. By contrast, only an average of 7% of ETFs distributed gains.
The author owns a long-term position in Fidelity Blue Chip Growth ETF. Contact her at Nellie.Huang@futurenet.com.
Note: This item first appeared in Kiplinger’s Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.
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