Actively managed ETFs: A contradiction?

Actively managed ETFs: A contradiction?

Communications

Actively managed ETFs (exchange-traded funds) have begun to gain popularity in recent years and now hold over $628 billion in assets under management. But what is an actively managed ETF? And how does it differ from passive management?

For investors, the term “actively managed ETF” is likely to arouse feelings of disbelief and surprise. An actively managed exchange-traded fund (ETF)? How is that even possible? Many may ask that very question, and with good reason. The truth is that since the first ETF of all time was launched in 1993, called the SPDR SPY, all those that came after it were passively managed products. That was until 2006, when the first actively managed ETF was created. However, their popularity and demand among investors has only started to grow in the last three years, when they managed to surpass $628 billion in market capitalization.

What is an actively managed ETF and how does it work?

A good definition for an actively managed ETF (exchange-traded fund) was given by Ben Johnson, Morningstar’s Director of European ETF Research. “ETFs are just a vessel, a wrapper in which asset managers package and distribute investment strategies to investors—active, passive, and everything in between,” explains the expert.

So what happens in an actively managed ETF? In this case, the manager could decide which companies to exclude or include. This means that the stocks that make up the product are no longer predetermined by the index, but rather by the subjective vision of the manager. The management team will be in charge of deciding which companies to buy, when to do so, what weight to give them, and even the possibility of including other types of assets such as bonds or commodities. In short, an actively managed ETF is more like a conventional investment fund; what changes is the packaging in which it is traded in order to reach a larger number of investors.

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Exponential growth in recent years

At the end of July of this year, the global ETF industry—including both actively and passively managed funds—had exceeded $10.86 trillion. This is over double the $4.8 trillion in assets under management recorded five years ago. Of that $10.86 trillion, $628 billion belong to actively managed ETFs, according to data from the specialist consultancy ETFGI. While they account for only 5.7% of the total market, they have grown by 28.8% since December 2022.

The inflow of capital into these funds goes hand in hand with the growth of the offering itself. Just ten years ago, there were only 153 actively managed ETFs worldwide, compared to the nearly 2,100 that can be found today. The bulk of the growth has occurred since 2020, with the volume under management rising from $288 billion to $628 billion and the number of ETFs listed from 1,053 to 2,072.

Advantages and disadvantages

It is clear that an actively managed ETF and a passively managed ETF are similar only in the way they are traded and in the way investors can include them in their portfolio. However, the content is very different. For example, in the case of one of the most popular passive ETFs, the Vanguard S&P 500 ETF (VOO), the product replicates, almost exactly, the composition and performance of the S&P 500. This formula gives the investor greater clarity and transparency with regard to the composition of the portfolio, both now and in the future. What’s more, in terms of costs, the expense ratio is 0.03%. However, this ETF does not allow the manager to make any changes to the portfolio, even if the market is bearish.

Meanwhile, in the case of the SPDR SSGA Global Allocation ETF (GAL), one of the most popular active ETFs, the manager invests in stocks as well as indices and bonds. This gives the investor a great deal of diversification with a single product. However, its composition will depend on the manager’s discretion and the investor cannot know what the manager may do over time. Furthermore, in terms of expense ratio, due to the fact that they are actively managed and require a greater effort on the part of the management team, the cost rises to 0.35%.

Distribution of active VS passive ETFs worldwide

Source: Statista | CoreData Research

Differences between investing in an ETF or a real asset

There are some major differences between investing through an ETF (collective investment scheme) and a real asset such as a stock or a commodity. Perhaps the biggest difference has to do with ownership. With a real asset, the investor owns that stock and owns a percentage of a certain company. Whereas by investing through an ETF, the investor does not own the stocks within the index, but rather the owner is, in this case, the management company.

The same happens if you invest in a gold ETF. The investor does not own the gold reserve, but rather has a right or an option. That being said, they do have exposure to the performance of the price of gold. In other words, what is delegated is the custody of the real asset, whether it is gold or a stock.