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Many are accustomed to active mutual funds but generally associate exchange-traded funds (ETFs) with being passive. However, this is not true as an ETF is just a wrapper. ETFs in Europe are UCITS funds in the same way as most mutual funds. So, in the same way you can have an active mutual fund, you can have an active ETF.
An active fund is managed by professionals who actively select securities in the portfolio with the goal of outperforming a specific benchmark or achieving superior returns. Unlike passive ETFs, which track a specific index, active ETFs rely on the expertise and research of fund managers to make investment decisions.
Active ETFs differ from traditional (passive) ETFs because they are managed actively rather than tracking a fixed index. Unlike mutual funds, active ETFs offer intraday trading, which allows investors to buy and sell shares throughout the trading day at market prices. Mutual funds, on the other hand, are only traded once a day at the closing price. ETF investors have everything in one place in their brokerage account, with other investments in stocks and bonds sitting alongside the ETF. It is easy to switch between investments or put more money into play.
For mutual funds with Asian exposures, it may be the case that if you place an order to buy today, you are getting tomorrow’s NAV. In the modern world it may be an alien concept that you buy something without knowing the price until the end of the day or the following day.
Additionally, they provide greater transparency by disclosing their holdings daily, while mutual funds typically disclose their holdings less frequently.
Expert fund managers use in-depth research, market analysis, and strategic decision-making to select and adjust an active ETF’s holdings. The managers monitor the market and make changes to the ETF’s composition based on their market outlook, economic conditions, and investment strategy to achieve their performance goals.
Benefits of investing in active ETFs include professional management, the potential for superior returns, greater transparency, and intraday trading flexibility. They are often more cost-efficient compared to mutual funds due to lower transaction costs and simpler fee structures.
ETFs, especially those domiciled in Ireland, offer tax advantages over other types of funds. In Europe, when it comes to holding US equities, mutual funds are typically subject to a 30% withholding tax (WHT). By contrast, Irish-domiciled ETFs are only subject to a 15% WHT, giving them a tax advantage when it comes to holding U.S. equities. To read the full tax advantages of ETFs, read our full article here.
Active ETFs generally have higher expense ratios than passive ETFs due to the active management component, as you are paying for the active manager’s expertise. However, active ETFs usually have a straightforward, all-encompassing expense ratio, making costs more transparent and easier to understand compared to the fee structures of mutual funds.
Potential outperformance is driven by the manager’s skill and their investment strategy, not the wrapper. Active management allows for more dynamic and tactical asset selection, which can capitalise on market opportunities. However, not all active funds succeed in outperforming their benchmarks, and performance can vary significantly.
When choosing an active investment, consider factors such as the fund manager’s track record, the fund’s investment strategy, and performance history. It’s also important to understand the ETF’s holdings, the market or sector it focuses on, and how it aligns with your investment goals and risk tolerance. Cost should also be a consideration, so you should compare fees to ensure they are justified by the fund’s potential for returns. When you invest in ETFs, your capital is at risk. You should always contact your financial advisor when making investment decisions.
Yes, risks include the potential for underperformance compared to the market or benchmark, higher fees compared to passive ETFs, and increased volatility due to the active management style. Active management relies heavily on the fund manager’s decisions, so the performance can be inconsistent and influenced by market timing and security selection errors. When you invest in any ETF, your capital is at risk.
The rebalancing frequency of active ETFs varies depending on the fund’s strategy and market conditions. Managers can adjust holdings as often as they see fit, ranging from daily to less frequent changes, to respond to market opportunities or risks. This is different from passive ETFs, which follow a set rebalancing schedule based on the index they track – for example monthly, or quarterly.
Yes, they can pay dividends to investors, just like traditional ETFs and mutual funds. The dividends paid are typically derived from the income generated by the ETF’s underlying holdings, such as stocks or bonds, and are distributed according to the fund’s dividend policy.
ETFs trade just like regular shares that are listed on a stock exchange. You can buy and sell them through a stockbroker, online share trading platform, or via your financial advisor. You can find more information on this by visiting our How to Buy & Sell ETFs page.
Spreads are generally driven by the average spreads of the underlying securites in the portfolio. There may be a small increase in active ETF spreads vs the equivalent passive ETF driven by factors such as the ability for market makers to fair value the ETF intra day when the portfolio manager is changing the shape of the portfolio. This is why the design of the active ETF is critical and where HANetf can help you.
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