Demand for exchange-traded funds (ETFs) has grown rapidly in recent years. While much of this growth has been driven by passive funds, research shows that investors are increasingly looking at active ETF strategies. Nevertheless, there are many common misconceptions about active ETFs. Here, we debunk the most common active ETF myths.
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Myth 1: Active management and ETFs don’t mix because ETFs are passive by definition |
ETF just means exchange-traded fund. This means ETFs can be traded on an exchange regardless of whether they are active or passive. In essence, an ETF is just a vehicle and there are a variety of strategies that can be used to leverage the benefits of the ETF structure. ‘Active’ refers to a portfolio management strategy where the manager makes specific investment decisions with the goal of achieving a specific outcome. Instead of just tracking an index and generating the market return (beta), typically active ETFs seek performance in excess of the benchmark (alpha) while maintaining the attributes of the ETF structure.
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Myth 2: Active ETFs are not relevant outside of the US market |
The rise of active ETFs is not constrained to a single market. While the US is leading the way, as of 2021 active ETFs account for 25% of exchange-traded products in Australia, up from 15% in 2017. 2021 was a record year for active ETF launches in Australia, with equity strategies accounting for the bulk of the new products.1 According to a recent survey, 70% of advisers who use ETFs include active approaches, and flows into active ETFs are expected to grow over the next two years.2 The rise of active has the potential to drive further ETF growth, providing investors with the opportunity to seek alpha on their investments while accessing the benefits they expect from an ETF vehicle.
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Myth 3: Active ETFs are expensive |
Total expense ratios (TERs) for passive ETFs vary and can range from below 0.10% to above 0.60%. Usually, core investments, such as global equities, are cheaper than more complex strategies, such as thematic ETFs. While specifics may differ from fund to fund, in general, the price points of active ETFs are comparable with those of passive strategies. Investors should seek financial advice and make independent evaluation based on their investment objectives and circumstances.
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Myth 4: Active ETFs are less liquid and more expensive to trade |
As with passive ETFs, a good active ETF will be backed by a dedicated capital markets team with a strong technology platform and strong relationships with a diversified set of authorised participants (APs). The ETF provider must be able to demonstrate that they can provide APs with all the information they need to deliver efficient pricing at all times, while utilising both primary and secondary markets to boost liquidity. If this is the case, trading active ETFs in terms of liquidity and price is no different to passive ETFs.
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Myth 5: Active ETFs do not make good core investments. |
Many investors use passive ETFs as core investments. Active ETF strategies can help investors build out the strategic core of their portfolios. The addition of active ETFs to a portfolio can provide diversification of products and ETF providers, and opportunities to enhance passive core performance by accessing active exposure to seek alpha.
What are the unique features of active ETFs?
While investors are still subject to the same broad risks as in any market-based investment, and the value of investments can fall as well as rise, an active ETF does provide opportunities to seek excess returns above a chosen index.
Because the weighting methodology in active strategies is at the discretion of the portfolio manager (within certain tracking error constraints), some active ETFs can also partly mitigate the limitations of market-cap indices, which can be more weighted towards larger market cap equities or more debt-carrying bond issuers. Depending on their investment objectives, some active ETFs may provide a more rigorous exposure to certain investment themes.
Before investing in an active ETF, investors should conduct due diligence in the same way as they would with a passive ETF or any other investment vehicle. Ideally, the active strategy will be based on a proven, repeatable process, a demonstrated history of investment expertise and an approach that aligns with investors’ risk tolerance and overall investment objectives.
1 Source: Morningstar article “Australia’s active ETF industry is on fire. Or is it?”, March 2022; data as of 31 December 2021.
2 Source: Wealth Insights 2022 ETF Report
