Active ETFs gaining prominence

Active vs. Passive ETFs?

What is the key difference between a passive ETF and an active ETF?

Passive ETF: an exchange-traded fund that typically tracks an index (e.g., S&P 500 or MSCI World), with the portfolio being updated only to reflect changes in the underlying index that it tracks.

Active ETF: an exchange-traded fund where an investment manager will actively manage a portfolio and attempt to outperform the index.

The key here is that active ETFs aim to outperform an index while a passive ETF will try to match the index’s return as closely as possible.

Many investors may think that active ETFs simply sound similar to mutual funds, however active ETFs retain the same structure as other ETFs, namely:

• Being listed on a financial exchange
• Retaining high liquidity on a secondary market
• Relatively lower management fees
• High transparency as to the underlying securities being held

In contrast, mutual funds are not listed on a financial exchange and do not have as much liquidity since they are not listed on a secondary market, which is also known as being closed-ended. Furthermore, active ETFs, while generally retaining a higher fee than passive ETFs, are still more cost-effective than mutual funds in most cases. 

Why Active ETFs are gaining traction

While active ETFs are gaining more inflows, they are not necessarily displacing passive ETFs. Both forms of ETFs are gaining more prominence as the benefits of the ETF structure are better understood,  especially among retail investors.

But in today’s challenging environment investors are increasingly looking for an investment that can provide a strong return with some protection against downside risk. Rules-based, passive ETFs, which rigidly track an index and are thus unable to respond to changing market conditions are, by their very nature, going to struggle to achieve this, which is what we’ve seen so far in 2022. 

Active managers, on the other hand, have the flexibility to direct their investments away from expected volatility, and therefore have a higher ability to protect investors from downside risk. 

Examples of Active ETFs

There are many different types of active ETFs today, all of which employ various strategies. Some common examples are:

• Dimensional U.S. Core Equity 2 ETF (DFAC)
• JP Morgan Equity Premium Income ETF (JEPI)
• PIMCO Enhanced Short Maturity Active ETF (MINT)
• ARKK ARK Innovation ETF (ARKK)

Data for this article is as of September 28, 2022.

Please note this article is for information purposes only and does not constitute investment advice.