The rise of active ETFs: Four reasons to consider active ETFs

Morgan Stanley Research

Learn more about active ETFs.

Exchange-traded funds are a staple in many investors’ portfolios, thanks to their relatively low costs, flexibility and potential tax efficiency. While many ETFs are designed to passively track an index or benchmark, an actively managed ETF is a fund with a manager or team making decisions about the holdings. They generally try to outperform a market index or other benchmark.

While actively managed ETFs have existed since 2008, demand for them is rising. Active ETFs represented $444 billion in assets as of October 2023,1 nearly triple the amount invested just three years earlier. There are 1,255 active ETFs2 currently traded on U.S. markets, up from roughly 350 in 2019. While they still comprise a small sliver of the more than $7 trillion ETF market,3 actively managed ETFs grew at a rate of 14% in the first half of 2023, compared to a 3% growth rate for passive ETFs.4

Potential Benefits of Active ETFs

Like a mutual fund, an ETF allows investors to easily invest in a bundle of assets like stocks, bonds or other securities. The key difference is that ETFs are traded on stock exchanges, which allows investors to trade ETFs throughout the day as market prices fluctuate. A mutual fund, on the other hand, is traded at the end of the day based on its calculated net asset value. Trading ETF shares in the stock market can impact the liquidity and the price of an ETF’s shares, though, as it’s possible that investors can sell their shares at a “discount” to what the ETF’s underlying holdings are actually worth.

Four potential benefits of ETFs include:

  1. Flexibility: ETFs allow investors to buy and sell throughout the day, providing liquidity while allowing investors to quickly take advantage of real-time news and opportunities.
  2. Tax efficiency: ETFs are typically designed to generate fewer capital gains distributions, which could help reduce the number of taxable events passed on to investors.
  3. Transparency: For some, but not all, actively managed ETFs, investors can see all the underlying holdings of an ETF on a daily basis, along with real-time share prices, allowing them to better understand how a specific ETF may impact their overall exposure to specific assets or sectors. Other actively managed ETFs share their portfolio holdings on a quarterly basis.
  4. Diversification: Investors can use ETFs to quickly gain diversified exposure to different asset classes, sectors, geographies, and strategies.

Unlike an ETF designed to replicate the performance of a specific index, active ETFs select specific investments to help achieve their investment strategies. Utilizing a stated investment objective or investment theme, they manage their portfolios with the goal of beating the performance of passively managed equivalents.

As a result, actively managed ETFs may offer investors tactical opportunities. For example, in active bond ETFs, investment managers can pick securities based on factors such as interest rate changes, global credit risks, duration or credit quality, and they can determine the size of their positions in these securities using fundamental or quantitative techniques. These portfolio managers typically aim to outperform passive index funds that follow the composition of benchmarks by finding opportunities amid the complexities and inefficiencies of the bond market, offering investors the potential for income, diversification and liquidity. Other types of active ETFs may include strategies that focus on equities, which may seek to deliver outperformance and/or income via dividend payouts or mitigate potential losses via options hedging.

Active ETFs seek to meet specific investor goals, while empowering active managers to leverage their expertise to try to capitalize on short-term market movements and long-term trends.

Active ETFs seek to meet specific investor goals, while empowering active managers to leverage their expertise to try to capitalize on short-term market movements and long-term trends. Plus, investors can potentially benefit from the tax efficiency of ETFs.

Keep in mind that there is no guarantee that active ETFs will achieve their investment objectives and you may lose money.

The source of this article, The Rise of Active ETFs, was originally published on December 11, 2023.

1 Morningstar, Here’s Why Active ETFs Are So Hot Right Now, Nov. 13, 2023.

2, Active Management ETFs, November 2023.

3 The Cerulli Edge—U.S. Monthly Product Trends, Aug. 3, 2023.

4 Morningstar, Global Fund Flows, First Half of 2023, Aug. 3, 2023.

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