What is an actively managed ETF?

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The first one exchange traded fund was the SPDR S&P 500 ETF (SPY), created in 1993. This passively managed index fund paved the way for thousands of ETFs to follow.

All of these initial ETFs were passively managed, like SPY, meaning they simply tracked the performance of an underlying index without any active intervention from fund managers. It wasn’t until 2008 that the first actively managed ETF arrived on the scene – the Bear Stearns Current Yield Fund – and it took another decade before actively managed ETFs really began to take hold.

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But what exactly are actively managed ETFs, and how they compare to passive ETFs and traditional mutual funds? Read on to discover the pros and cons of this relatively new asset class.

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How do actively managed ETFs differ from passively managed ETFs?

Most investors are familiar with S&P 500 index funds like SPY and IVV. These funds passively track the performance of the S&P 500 index without any intervention from the manager. In other words, these index funds own the S&P 500 stocks and add or replace them as the index itself moves. Managers do not have the ability to choose their own stocks to add or remove from the ETF’s portfolio.

Actively managed ETFs, on the other hand, are portfolios fully controlled by professional fund managers, who buy and sell investments that will meet the ETF’s written objectives.

For example, the largest actively managed ETF currently is the JPMorgan Equity Premium Income ETF, with approximately $33.59 billion in assets. Rather than tracking an underlying index, this ETF owns stocks hand-selected by its managers and then sells call options against them, generating monthly income for investors. This type of investment strategy obviously requires active and knowledgeable managers who can both select the right stocks and sell the right options to generate income. It is therefore best served in an actively managed ETF format.

Other actively managed ETFs simply use managers to select individuals actionsbonds or other investments on behalf of investors, in accordance with their written objectives.

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What about traditional mutual funds?

In a sense, actively managed ETFs are similar to traditional ETFs. mutual fundwhose development has taken place in the opposite direction to that of ETFs.

The first traditional mutual funds – and in fact, the vast majority of them still today – were actively managed, with only a few passively managed funds now available. In 2022, for example, there were 6,585 actively managed mutual funds, but only 517 passively managed, a ratio of almost 13:1.

The story continues

In this sense, actively managed ETFs take inspiration from their traditional predecessors, with professionals picking and choosing individual investments on behalf of investors. However, the main difference between actively managed ETFs and traditional mutual funds is that ETFs, as the name suggests, trade on stock exchanges. This means they can be bought and sold at any time when the market is open. In contrast, traditional mutual funds can only be bought and sold once a day, after the market closes.

What are the advantages and disadvantages of actively managed ETFs?

Actively managed ETFs, like any investment, have advantages and disadvantages. Whether or not they are a good investment for you depends on your goals, risk tolerance and personal preferences. Here are the main advantages and disadvantages of investing in actively managed ETFs.

Benefits

• Typically lower expense ratios than traditional actively managed mutual funds

• Professional management rather than blind tracking of indexes

• Potential for higher returns through expert management

• Can be bought and sold at any time when the market is open, unlike traditional mutual funds.

The inconvenients

• Expense ratios are generally higher than those of passively managed ETFs or mutual funds.

• Have the potential to underperform passively managed ones if managers make poor choices

• Investors may not know exactly what’s in an actively managed portfolio, unlike what’s in an index fund.

The essential

On the surface, actively managed ETFs look and trade like their passively managed counterparts. However, under the hood there is much more going on. Professional fund managers pick and choose individual stocks, often without investors’ knowledge until the funds release their monthly or quarterly updates.

If you think the managers you hire can outperform stock indexes, then an actively managed ETF may be right for you. But since most active managers struggle to beat the market consistently, you’ll need to make sure you choose exceptional managers.

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This article was originally published on GOBankingRates.com: What is an actively managed ETF?

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