The growth of actively managed exchange traded funds (ETFs) across the world is well documented. Janus Henderson recently expanded its own footprint, acquiring an ETF business in Europe.

But what does this mean for investors? What do you need to know when considering investing in active ETFs versus more traditional mutual fund vehicles?

In this guide, we look at some of these considerations and provide practical insights on how active ETFs can be used in an investor’s portfolio.

Common misconceptions

First and foremost, it’s important to clarify one of the biggest misconceptions on ETFs – that they are passive strategies i.e. managed to an index. It is true that historically, most ETFs in the market place have been passive strategies but that is no longer the case.

ETFs are as they suggest – exchanged traded funds. That is, funds that can be bought and sold through a stock exchange much like a stock or a bond. Those funds can be active or passive. The key difference is simply how investors buy or sell the strategy. As figure 1 shows ETFs bring together the benefits of both.

Figure 1: Active ETFs incorporate the attributes of a stock into a fund vehicle

Portfolio construction considerations

The answer to whether an active ETF or mutual fund is preferable when building a portfolio largely depends on the nature of the portfolio and how it will be managed. There is no right or wrong answer but there are important considerations when looking at the alternatives.

When an active ETF could be preferred

• Highly active portfolio management: While we strongly advocate for time in the market rather than timing the market, active ETFs can be an excellent way to gain exposure to active strategies while also allowing for intraday transactions. This can become particularly important when material market events are likely to have an ongoing impact (positive or negative) on returns.
• Small accounts: For smaller accounts or for satellite holdings, active ETFs could fill the void where the minimum account sizes of mutual funds are prohibitive. Where a mutual fund will typically have higher minimums and trading sizes, an ETF can be bought or sold for as small an amount as one “share” – which could be as low as £1.
• Rebalancing: Intraday trading and small minimum trade sizes mean that investors are able to rebalance portfolios more accurately and more frequently – providing the benefits of the rebalance outweigh the trading costs. An active ETF allows investors to redeem (or add to) the holding at any time throughout the day at intraday pricing.
• Blending: The greater level of transparency afforded by active ETFs permits more exact portfolio blending with other holdings. In contrast, mutual funds typically disclose only their top 10 holdings on a monthly basis, while active ETFs can disclose their full holdings daily.
• Efficiency: The mechanics behind active ETFs are simple, standardised and highly efficient. This helps to keep trading costs down and means they are also operationally convenient for investors.
• Contrary or “short” positions: It is possible to short some ETFs thus taking the other side of the trade.
• Leverage: Some prime brokers / banks will allow margin lending to be run against ETF positions should investors wish to do so.
• Pricing: Active ETFs are unable pay sales commission to advisers (in Europe) and hence do not have these commissions built into the ongoing charges figure. This allows a non-advised client to access strategies free of such charges.

When a mutual fund could be preferred

Of course, there remains many reasons why mutual funds remain a preferred approach for many investors.

• Long-term time horizon: A major benefit of active ETFs is accessibility and ease of transaction. For many components of a portfolio, investors should be taking a long-term time horizon with their investment. As such, the ability to trade intraday shouldn’t be a necessary feature. Even during times of significant market volatility, rarely does trying to time the market result in better financial outcomes.
• Valuation certainty: An active ETF has two valuations: 1. Net Asset Value (NAV) and 2. share price. Generally, these two should track each other closely and ETF issuers have techniques to ensure that occurs. However, there can be some deviation between the two. A mutual fund just has the NAV and, therefore, the price offered per share aligns to the value of the fund’s assets. Further, if an adviser is buying (or selling) on behalf of underlying clients then all clients will buy (or sell) at one price – this is impossible to achieve for ETF purchases.
•  Range of options: Currently, the majority of active strategies are offered via mutual funds. Therefore, it may not be feasible at this moment in time to build an entire active portfolio out of ETFs.
•  Availability: Many platforms have yet to fully engage with active ETFs. As a result, investors may find that the mutual fund approach remains the most effective approach, at least in the near term.

Selecting an active ETF – key considerations

For an investor considering an active ETF, there are several questions that should be asked:

• How closely does the active ETF strategy reflect the manager’s existing strategy i.e. is this a genuine strategy or an adapted version?
• What are the trading costs to buy and sell the holding?
• Does the ETF trade at a material discount (or premium) to the NAV?
• How is liquidity guaranteed?
• Can a suitable collection of active ETFs be accessed with the platform/provider used?

We believe that active ETFs have a very promising future as evidenced by their increasing popularity among investors. But as with any investment, it’s crucial to carefully examine the construction, management, and listing details of the ETF.

IMPORTANT INFORMATION

Past performance does not predict future returns.

There is no guarantee that past trends will continue, or forecasts will be realised.