ETFs | November 22, 2019

Active ETFs: What You Should Know

At first glance, actively managed exchange-traded funds (ETFs) might seem like a contradiction. After all, most ETFs are considered passive investments because they’re designed to replicate the performance of specific market indexes rather than outperform them.

Active ETFs, on the other hand, rely on fund managers to select assets in response to changing market conditions. Broadly speaking, their goal is to deliver returns in excess of whatever index they use to benchmark their performance.

While actively managed ETFs are growing in popularity—with record inflows of $27.5 billion in 2018—they currently represent only about 2% of the $3.4 trillion U.S. ETF market. And most active ETF money is in ultra-short bond funds.

“That’s because, with short-term interest rates so low, some fixed income fund managers are assuming a bit more risk as they strive to generate additional returns,” says Michael Iachini, vice president and head of manager research at Charles Schwab Investment Advisory. Should the current bull market begin to lose strength, equity fund managers may follow suit.

But while better returns might sound appealing, there are other aspects to consider. “These funds likely will have fees that fall somewhere between those of a garden-variety index fund and those of an actively managed mutual fund,” Michael says. “And additional fees come at a cost to returns.”

Risk is another factor. “In pursuit of greater returns, active ETF managers must, by definition, take on additional risk,” Michael says, “so investors will want to take that into consideration, as well, before seeking to beat the market.”

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