Related topics: ETF, stock market, investing strategy, funds, Morningstar
Since their debut in the 1990s, exchange-traded funds have increasingly gained ground on traditional mutual funds. Total ETF assets under management in the United States topped $1 trillion in 2010, reflecting investors' growing attraction to the funds' low fees, transparency, tax efficiency and stock-like characteristics.
But until recently, mutual funds offered something that ETFs could not: active management.
Traditional ETFs simply track an index (for example, an S&P 500 ETF invests in the holdings of the Standard & Poor's 500 Index ($INX), but a new breed called "active ETFs" are piloted by portfolio managers who make buy and sell decisions.
Today, there are more than 30 active ETFs available to retail investors (the first was introduced in 2009). Experts say there's plenty of pent-up demand for these funds, and they expect the category to grow significantly; more than two dozen money managers have pending applications with the Securities and Exchange Commission for actively managed funds.
"This will be the year of the active ETF launch," says Scott Burns, the director of ETF analysis at Morningstar.
One reason active ETFs have been slow to come to market is that many fund companies have had to wait a year or more for SEC approval. Also, because ETFs require more frequent disclosure than mutual funds, some managers have been reluctant to commit to running an active ETF.
So far, active ETFs that invest in bonds have attracted the most investor dollars (Pimco Enhanced Short Maturity Strategy ETF (MINT) is the largest active exchange-traded fund), mostly because investors have opted for fixed-income funds over stock funds since the depths of 2008's financial crisis.
Active ETFs look a lot like actively managed mutual funds. Both are headed by a manager who chooses securities with the goal of beating a given benchmark index.
Some invest in a number of underlying funds, and others have flexible mandates, such as the ability to invest in a range of asset classes throughout the world.
But there are differences between active ETFs and actively managed mutual funds, including how they trade throughout the day and how trading is taxed.
Here are four reasons to consider active ETFs:
- Lower fees. ETFs are generally cheaper than mutual funds. The average annual fee of an actively managed U.S. stock mutual fund is 1.39%. according to Morningstar, while the average fee for an active U.S. stock ETF is 0.82%. (Of course, traditional passively managed ETFs remain the cheapest. The average U.S. stock ETF charges only 0.49%.)
Morningstar research has found that the cheapest funds outperformed the highest-cost funds in every asset class over different time periods ranging from three to 10 years. - Greater liquidity. ETFs trade on exchanges like stocks, so investors can buy and sell shares of ETFs throughout the day. Mutual funds, on the other hand, are priced only once a day, at the end of trading.
- More transparency. ETFs release a list of their holdings on a daily basis, while mutual funds generally report holdings on a monthly basis. If a fund is only tracking the S&P 500 Index, for example, investors typically can know what the fund is invested in at all times, because the allocations of the index don't change very often. But active managers can make much more frequent changes to their portfolios.
