Actively Managed ETF, Definition and Explanation
An actively managed ETF has a portfolio manager(s) that decides how ETF capital is allocated, based on a strategy laid out in the ETF’s prospectus. Holdings (what it invests in) within the ETF may change constantly (or rarely) as mandated by the strategy.
Actively managed ETFs often don’t track an existing index, although ETFs create indexes so investors can compare the performance of the ETF to an index. Unlike a traditional index, like the S&P 500, which doesn’t change holdings very often, an index created by an ETF will change its holdings as often as the strategy that created the index says it should.
For example, if an ETF were created that bought stocks moving above their 200-day moving average, and sold stocks that dropped below their 200-day moving average, then each day some new stocks would be added to the index and some others will drop off the index. The index reflects the theoretical profits (or losses) associated with such a strategy. The ETF attempting to replicate the index incurs trading fees in making those transactions. The ETF also charges investors a management fee and may have tracking errors, which all can cause the returns of an ETF to deviate from the index returns.
Why is this important? Because actively manged ETFs have a harder time tracking their index than passive funds do. Passive funds don’t alter their holdings frequently, and therefore incur fewer costs and are more likely to track their index with a high level of precision.
Pros and Cons of an Actively Managed ETF
On the negative side, most investors won’t be sure what they are getting with an actively managed ETF. Some actively managed ETFs are complex, and since the holdings within the fund change, investors who don’t understand the strategy the fund is employing may not be buying what they think they are. If you already have multiple ETFs, stocks or commodities in your portfolio, you may end up over-exposed to certain sectors or stocks if the actively managed fund invests in them as well.
Actively managed ETFs also tend to have higher expense ratios (the percentage per year the fund charges you for being an investor) than passive ETFs. This is only a problem if the actively managed ETF under-performs passive ETFs. Sometimes paying extra for something is worth it, sometimes it isn’t.
On the other hand, actively manged ETFs can provide some diversification benefits, since the funds are not based on traditional indexes.
Actively managed ETFs should be based on a solid investing premise (some are, some aren’t), which means theoretically there is higher return potential. Unfortunately that isn’t always the case. See how all ETFs perform over various time periods using the Finviz screener on ETFs.
ETFDB.com: List of actively manged ETFs
VantagePointTrading: How to Find Good Dividend Stocks to Invest In