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Everything you need to know about actively managed ETFs

Passive investing strategies are common and popular among investors when it comes to exchange-traded funds (ETFs). Passive ETFs track multiple indexes, and have a low turnover and a low cost attached to them. In the past, passive strategies gained an edge over actively managed ones due to their better performance. Even if actively managed ETFs are not popular, they have larger profit margins and do attract a specific set of investors. ETFs allow intraday trading, which enables the investor to actively manage their ETF and make changes multiple times in a day. Here is some crucial information about actively managed ETFs.

What are actively managed ETFs?
An exchange-traded fund can be built to track multiple picks of an investment manager, a mutual fund or even to track a particular index, with the latter being the most popular type. Multiple index tracking is associated only with actively managed ETFs. Active management often delivers above-average returns. Actively managed ETFs posses the ability to provide benefits to mutual fund investors as well as fund managers. Different tracking options attract different types of investors and traders. For example, an ETF that tracks mutual funds will appeal to frequent traders as they can make multiple intraday trades to reap the highest benefits. However, these trades will focus on the actively managed ETF and not the mutual fund. Thus, the mutual fund does not see an inflow/outflow of cash, thereby making it easier to manage the cost of the ETF.

Breakdown of actively managed ETFs
Actively managed ETFs and traditional ETFs share similar benefits and properties such as price, liquidity, and tax efficiency as well as transparency. However, actively managed ETFs require a moderately active fund manager who can adapt to swiftly changing market conditions. Together, active management and ETFs provide the right solution for asset management. Investors are usually attracted to the lower expense ratios, active participation of financial experts, and the possibility of reaping outstanding returns. However, there is an uncertainty of an ETF’s performance beyond predictions and assumptions. It can underperform or outperform a passive ETF.

New ETF trends
Our market has a large ETF space, but actively managed ETFs consist of only about $4 trillion of the entire space. According to a report by US News, the market is home to roughly 230 actively managed ETFs, with around 50 of them being new entrants, launched last year. This substantial growth in the past year relates to the increasing interest for actively managed ETFs among investors. Many analyzers have said that this trend and growth in actively managed ETFs is likely to continue for the next few years.

According to the work of a research firm, actively managed ETFs and related vehicles gathered $24 billion in 11 months of 2017, making it the most fruitful year for these funds. Their popularity was not only surprising, but it also marked an increase of over 50% from 2016, becoming the single largest increase that the sector has seen since 2009.

There is speculation that their popularity has led to a few scams, where even passive ETFs were passed off as active ETFs by adding the word “active” to their product description in a bid to get better purchase.

Benefits and risks of actively managed ETFs
One of the key benefits of an actively managed ETF is the possibility of intraday trading. Thus, traders have a degree of flexibility that is not available with a passive ETF. They are usually compared to other mutual funds but actively managed ETFs provide lower expense ratios which is a popular attraction. There are several brokers that deal in actively managed ETFs. The pricing of these ETFs will depend on the broker who is approached. Besides the benefits, actively managed ETFs also hold a risk of underperformance. They are often associated with above-average objectives which directly increases the possibility of underperformance. As for the long run, most investors prefer investing in a passive ETF as compared to actively managed ETFs.

Limitations of actively managed ETFs
Actively managed ETFs might be similar to traditional ETFs and other forms of mutual funds in many ways, but they have a higher premium and maintenance attached to them. As an actively managed ETF grows, the expense ratio could also raise along with it. For example, a week of underperformance for an actively managed ETF could increase the expense ratio significantly. Funds managers are under a lot of pressure to keep the performance high and expense ratio low.

This performance pressure is associated with other mutual funds as well. Some mutual funds regularly deliver great performance while others struggle, and this depends mostly on the fund manager and their expertise. However, research has shown that active management underperforms most passive strategies in the long run. They are also seen to contradict principles such as diversification.

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