Active Management ETF (Exchange Traded Fund)
An ETF or an exchange traded fund is a fund which invests either in stocks, commodities or currency. The units of these funds are traded on the exchange. The investments are made by fund managers and investors can invest by buying units of these ETFs.
An exchange traded fund may be a passive management ETF or an Active Management ETF (Exchange Traded Fund).
- Passive Management ETF: When the concept of ETFs in stocks was introduced, an ETF tracked a particular benchmark index. This meant that a stock ETF made investments in companies which formed a particular market index. These investments were not shuffled and were passively managed. Even today, many exchange traded funds are passive management ETFs and mirror the returns of the benchmark index.
Many investors were not satisfied with these returns. They wanted their investments to outperform the benchmarks and this resulted in the introduction of the active management ETF (Exchange Traded Fund).
- Active Management ETF: Active management ETFs are those funds which keep making changes in their respective portfolios. The investors of an active management ETF expect above average returns from their investments.
Differences between a Passive and Active Management ETF (Exchange Traded Fund):
- While passive management ETFs track a particular benchmark, an active management ETF aims at beating the benchmark.
- The expenses of an active management ETF are higher than the expenses of a passive management ETF. This is because the turnover of the former is much higher due to frequent changes in the portfolio.
Though a mutual fund and an Active Management ETF (Exchange Traded Fund) have many similarities, they have the following differences:
- Liquidity: Mutual funds cannot be bought and sold on the exchange. Units of active management ETFs are traded on the exchange. Hence ETFs are more liquid than mutual funds.
- Profit calculation : Mutual funds use the ‘highest in- first out’ method to calculate profits for tax purposes whereas active management ETFs use the ‘lowest in – first out’ method. Capital gain benefits in ETFs are therefore higher than in mutual funds.
- Transparency: Active management ETFs report their holdings on a daily basis unlike mutual funds which declare their holdings only once in a quarter. Exchange traded funds are thus more transparent than mutual funds.
Problems faced by an Active Management ETF (Exchange Traded Fund):
Since exchange traded funds disclose their holdings on a daily basis, many copycat investors try to profit by imitating the trades of the ETFs. Exchange traded funds try to prevent or at least limit these activities by focusing on heavily traded stocks which are not very susceptible to negative price movements caused by the copycats. Another tactic used by ETFs is the use of multiple fund managers. Investors would want to imitate the activities of a successful fund manager. When there are many fund managers, one would not know which manager was responsible for a particular trading move and hence imitating would be difficult.
An active management ETF(Exchange Traded Fund) is beneficial to an investor who prefers active investing but does not have the time or expertise to actively manage his portfolio. By investing in an actively managed exchange traded fund he can profit from the experience and expertise of professional fund manager.