The term "actively managed exchange-traded fund" sounds like a contradiction in terms. A chief selling point of ETFs, after all, is that they're indexed, or passively managed, which keeps a lid on costs. But now asset managers including Putnam Investments, T. Rowe Price (TROW), Vanguard, and Pimco are racing to cash in on the growing interest in actively managed ETFs. So just what's the appeal of having a real live portfolio manager at the helm of an ETF? %%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%%"Individual and institutional investors can get mutual-fund or hedge-fund strategies with much greater liquidity and lower cost," says Joel Shulman, an associate professor of entrepreneurship at Babson College, who is creating a series of actively managed, entrepreneur-related ETFs. John Woerth, a spokesperson for Vanguard, which plans to issue an ETF share class of its Vanguard Inflation-Protected Securities Fund (VIPSX), puts it more bluntly: "The appeal is the potential to outperform the market."
Underperforming the Index
Recall that an indexed product, whether a mutual fund or an ETF, can never beat the market, as it only tries to mimic the performance of a benchmark like the S&P 500. Throw in costs, slim as they may be, and passively managed vehicles will always slightly underperform their indexes.
Another benefit of active management stems from the fact that ETFs trade on an exchange like stocks, whereas mutual funds price only once a day. That affords flexibility from a trading perspective, says Bryan Place, a certified financial planner and founder of Place Financial Advisors. Investors and advisors can sell covered calls, employ stop-loss orders, and hedge position -- none of which are options with mutual funds, he says. "As evidenced by last year's trading volatility, the ability to get out of a position at noon versus the day's close can be significant," Place says.
Actively managed ETFs also differ from actively managed mutual funds, in that, depending on how they operate, the former might cost the taxable investor less in taxes than an active mutual fund with similar holdings. "So if there's an advantage to an active ETF, as compared with an active mutual fund, at least, it's potentially lower taxes," says Michael Edesess, chief investment officer and partner with Fair Advisors.
Struggling for Investors
But actively managed ETFs, which debuted more than a year ago, have yet to gain much traction with investors. "All of the actively managed ETFs are thus far having difficulty attracting funds," says Shulman. Generally, active funds can't compete with passive funds, because active funds charge higher fees, says Edesess. "If their fees were the same, they'd be about equally attractive," he says.
So who might be best suited for actively managed ETFs? "The investors who can benefit from [these] ETFs are those who believe in active management based [outperformance], those who are no longer interested in pursuing a traditional 'buy and hold' approach, and those who are generally fed up with the incompetence in mutual funds and their historically bad performance," says Jack Reutemann, founder of Research Financial Strategies.
Edesess, however, thinks actively managed ETFs make little sense for the vast majority of investors, since the evidence shows that lower-fee passive funds and ETFs offer better returns than higher-fee active funds and ETFs. "If there's someone for whom active ETFs are better than active mutual funds, the answer is taxable investors," he says.
Introduction to ETFs
The basics of Exchange Traded Funds and why ETFs are hot.View Course »