In essence, Active ETFs are a new breed of exchange-traded funds that combine the benefits of ETFs with the benefits of active management. The benefits of ETFs are well-known and widely accepted, which is what has lead the ETF industry to surpass the $1 trillion mark recently, in terms of assets being managed. However, that is dwarfed by the behemoth of the US mutual fund industry which collectively manages in excess of $12 trillion and a large portion of these assets lie in actively-managed mutual funds. Active ETFs are innovations that are trying to bridge this gap and provide the low cost, tax efficient structure of ETFs to investors who believe in active management.
Active ETFs vs Actively-Managed Mutual Funds
There are numerous points that differentiate these two types of investment instruments that both utilize active management strategies.
1. Active ETFs provide tax advantages over active mutual funds. The ability to have in-kind creation and redemption allows investors to avoid adverse tax consequences that are experienced by mutual funds which involve cash transactions when units are redeemed. This mechanism of ETFs minimizes taxable capital gains that result from redemptions. These tax advantages are common across all ETFs.
2. Active ETFs are also much more transparent than their mutual fund counterparts because ETFs have to disclose their portfolio holdings on daily basis while mutual funds may make such disclosures only once every 3 months. This ensures that the ETFs’ price does not deviate from their NAV too much.
3. And finally the hallmark of Active ETFs, including ETFs in general, is their much lower expense ratios compared to mutual funds. For example, a case in point is the newly launched PIMCO Intermediate Municipal Bond Fund (MUNI), which is an Active ETF, compared to the PIMCO Municipal Bond Fund A (PMLAX), which is a mutual fund. Both funds are managed by the same portfolio manager, and have nearly identical investment strategies. However, the mutual fund has a net expense ratio of 0.75% (aside from a sales charge of 3.75%) while the Active ETF has an expense ratio of just 0.35%.
Active ETFs vs Passively-Managed ETFs
Nearly the entire ETF industry is currently made up of Index ETFs, with Active ETFs only managing around $140 million in total. These Index ETFs are designed to track a certain index and their mandate is merely to replicate the returns of the index. The expenses on Index ETFs are usually smaller than those for Active ETFs. In contrast, Active ETFs are managed by portfolio managers who take active positions to provide alpha or excess return over their benchmark. Though as a result of this, Active ETFs have higher turnover and hence transaction costs, which partially explains the higher fees.
The number of issuers providing Active ETFs is exploding, with many new filings in the works. The long-term future of Active ETFs will depend largely on whether they do any better than mutual funds in beating their indexing counterparts. So place your bets!
Disclosure: No positions in Active ETFs.
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