Active ETFs investing: four myths debunked
Demand for ETFs has grown rapidly in recent years, especially for active ETFs. However, there are still many common misconceptions when it comes to investing. See below.
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Myth 1: Active management and ETFs don’t mix because ETFs are passive by definition |
ETFs are investment funds traded on an exchange, regardless of whether they are active or passive. Essentially, an ETF is just a vehicle, and there is a variety of strategies that can be used to take advantage of the benefits of the ETF structure. “Active” refers to a strategy in which the manager makes specific investment decisions with the goal of maximizing results. Instead of simply tracking an index and delivering market returns (beta), active ETFs typically seek to outperform the benchmark (alpha) while retaining the attributes of the ETF structure.
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Myth 2: Active ETFs are expensive |
While details can vary from strategy to strategy, in general, active ETF pricing is comparable to that of passive strategies.
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Myth 3: 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 authorized 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 utilizing 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 4: 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 of any market-based investment—and investment values can fall as well as rise—an active ETF offers opportunities to seek returns that exceed an index. Because the weighting methodology in active strategies is at the portfolio manager’s discretion (within certain tracking error limits), some active ETFs can also partially mitigate the limitations of market-cap-weighted indices, which may be more concentrated in larger-cap stocks or in bond issuers with higher levels of debt. Depending on their investment objectives, some active ETFs may provide more targeted exposure to specific 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.