Active vs. Passive ETF Investing: An Overview

Exchange-traded funds (ETFs) first started trading in the United States in the 1990s. Today, they are available in hundreds of varieties, tracking nearly every index you can imagi🍌ne.

ETFs can offer all of the benefits associated with index mutual funds, including low turnover, low cost, and broad 澳洲幸运5开奖号码历史查询:diversification. In addition, the 澳洲幸运5开奖号码历史查询:expense ratios of passively-managed ETFs can be lower than thos💎e for similar mutual funds.

Passive ETF investing is a popular strategy among investors who prefer a long-term, buy-and-hold approach to investing their money. On the othe🐻r hand, active ETF investing, which involves fund managers actively trading securities within an ETF to outperform an index, is an alternate route that many investors may choose.

Here we explore ETF inves🅷tment s🧔trategies to provide insight that may help you in your investment decision-making.

Passive ETF Investing

澳洲幸运5开奖号码历史查询:Passive investing is an approach to investing that focuses on tracking and achieving the return of a specific index. It involves limited transactions. In fact, ETFs were originally constructed to provide invest⭕ors wit🍸h a single security composed of many assets that simply would track indexes.

For example, some passive ETFs track the S&P 500 index or the Nasdaq. This means 🀅investors gain exposure to the entire markets re♋presented by these indexes.

Therefore, the fund manager of a passive ETF isn't making allocation decisions or conducting trades beyond those that take place in the index itself.

Thus, passive ETF investing provides a convenient and low-cost way to implement indexing or passive investment management. This is especially attractive to those investors who wish to 澳洲幸运5开奖号码历史查询:buy and hold securities (rather than engage in trading them) for the long-term.

Intraday Trading

ETFs also trade throughout the day just like individual stocks. This intraday trading allows investors and active tradꦯers to buy and sell ETFs at their discretion, unlike mutual funds, which trade only once per day.

While the ability to trade throughout the day ca🔴n be a boon for certain investors, such trading can result in unnecessary transaction costs. Those costs can a♔ffect investor returns. That is a fundamental difference between the strategies of passive and active ETF investing.

According to Morningstar, most 澳洲幸运5开奖号码历史查询:actively managed funds fail to beat their benchmarks or passive ETF counterparts, especially over longer time horizons.

Active ETF Investing

Trading a Passively Managed ETF

Despite indexing's ability to achieve the returns represented by indexes, many investors aren't content to settle for so-called average returns.

Even though they may know that a minority of actively managed funds beat the market, many are still willing to try active investing using their passively managed ETFs. That is, they'll trade their ETF to attempt to track short-term market movements. If the S&P 500 races upward when the markets open, active traders can lock in the profits immediately by selling their ETF.

Importantly, all of the 澳洲幸运5开奖号码历史查询:active trading strategies that can be used with traditional stocks can also be used with ETFs, such as market timing, sector rotation, short selling, and buying on margin.

Actively Managed ETFs

Actively managed ETFs differ from the concept of passively managed ETFs 🐎that are actiꦡvely traded by investors (as described above).

Actively managed ETFs involve a fund manager or management team that researches investment opportunities and actively selects the ETF's portfolio securities and allocation, according to the investment goals that they seek to reach.

These ETFs can provide investors/traders with an investment th💃at aims to deliver aboꦇve-average returns. 

Actively managed ETFs have the potential to benefit mutual fund investors and💧 fund managers as well🌺. If an ETF is designed to mirror a particular mutual fund, the intraday trading capability will encourage frequent traders to use the ETF instead of the fund.

This will reduce cash flow 澳洲幸运5开奖号码历史查询:in and out of the mutual fund, making that portfolio easier toꦐ manage and more cost-effective. In turn, this can enhaꦅnce the mutual fund's value for its investors.

Transparency and Arbitrage

Actively managed ETFs are not as widely available as index ETFs because there is a technical challenge in creating them. This involves a trading complication related to the role of 澳洲幸运5开奖号码历史查询:arbitrage.

Because ETFs trade on a stock exchange, there is the potential for price disparities to develop between the trading price of the ETF shares and the trading price of the 澳洲幸运5开奖号码历史查询:underlying securities. This creates the opportunity for arbitrage.

If an ETF is trading at a value lower than the value of the underlying shares, investors can profit from that discount by buying shares of the ETF and then cashing them in for 澳洲幸运5开奖号码历史查询:in-kind distributions of shares of the underlying stock.

If the ETF is trading 澳洲幸运5开奖号码历史查询:at a premium to the value of the underlying shares, investors can short the ETF and purchase shares of stock on the 澳洲幸运5开奖号码历史查询:open market to cover the position.

With index ETFs, arbitrage keeps the price of the ETF close to the value of the underlying shares in the index. This works because the holdings in a given index are known. Investors in index ETFs have nothing to fear from the disclosure of their holdings. Price parity serves everyone's best interests.

The Challenge of Disclosing Holdings

The situation is different for an actively managed ETF whose 澳洲幸运5开奖号码历史查询:money manager gets paid for stock selection. Ideally, those selections are made to help investors 澳洲幸运5开奖号码历史查询:outperform the ETF benchmark index. If the ETF disclosed its holdings frequently enou𓄧gh so that arbitr♉age could take place, there'd be no reason to buy the ETF.

Smart investors would simply let the 澳洲幸运5开奖号码历史查询:fund manager do all of the research and then wait for the disclosure of thei𓆉r best ideas. The investors would then buy the underlying securities and avoid paying the fund's management expenses. Therefore, such a scenario provides no incentive for money managers to create actively managed ETFs.

SEC Allows Non-Disclosure

Up until 2019 in the U.S., actively managed ETFs were required to be transparent about their daily holdings. However, in 2019, the Securities & Exchange Commission (SEC) approved the practice of non-transparency (not disclosing holdings each day). As a result, actively managed ETFs that don't disclose holdings daily are required to make clear to investors the lack of transparency and the risks involved.

The SEC has also approved opening stock trading without price disclosures on volatile days. This is due to the record intraday drop that occurred in August 2015, when ETFs prices dipped because securities' trading halted while ETF trading continued.

Portfolio Management Fees

Active ETFs tend to have higher management expenses compared to passive ETFs. As discussed earlier, this is because the fun🥂d's assets are selected and overseen by a portfolio manager who is making active investment decisions in an attempt to outperform the benchmark index.

The fees for active ETFs typically cover the costs associated with research, trading, securi꧋ty selection, and ongoing management of the portfolio.

Passive ETFs are known for their cost-efficiency, and they generally have lower management fees. The pri🍒mary objective of passive ETFs is to replicate the performance of a specific be⛄nchmark index or asset class without requiring active decision-making.

Since there is no active manager trying to beat a benchmark, there is also often less of an administrative fee. This is because most passive ETFs rely on a rules-based approach that doesn't involve the ongoing costs associated with active research or security selection.

Performance Expectations

Active ETFs

Investors in active ETFs have performance expectations that are tied to the skills and expertise of the portfolio managers. The fundamental premise of active management is to generate alpha, wh🧔ich represents returns above and beyond the benchmark index.

These managers seek to identify undervalued or overvalued assets, make strategic asset allocations, and time the market to cap༺italize on opportunities and mitigate risks. In many ways, active ETFs create greater opportunities to deviate from standard market returns.

Passive ETFs

In contrast, passive ETFs have a very different set of performance expectations. The primary objective of passiꦕve management is to replicate the performance of a specific benchmark index, allowing investors to participate♔ in the overall market or a specific asset class.

Therefore, investors in passive ETFs can exp♋ect returns that closely mirror the returns of the chosen benchmark without the performance expectation of beating that index.

It's important understand that passive ETFs aim to minimize 澳洲幸运5开奖号码历史查询:tracking error, the deviation between the ETF's returns and the benchmark index's returns. T♏herefore, the basis for evaluating a passive ETF's performance may not necessarily be the annual return it yields but how ꧒closely it mirrored the index it is trying to mimic.

The Bottom Line

Ac🌳tive 𒁃and passive management are legitimate and frequently used investment strategies sought by ETF investors.

As an investor, if you prefer a long-t൲erm, buy-and꧋-hold approach to building wealth, then passive ETF investing may be right for you.

Alternatively, if you seek the potential for returns that outpಌace those offered by the broad market and other indexes, then you may wish to consider and include active ETFs in your portfolio.