Investors who once considered ETFs to be a black-and-white proposition are discovering that these popular investment vehicles are now available in many shades of grey.
There aren't 50 shades yet, and for all their attractiveness, no one would call exchange-traded funds sexy. Yet the newer breed is a bit unconventional – they are actively managed, unlike more traditional, passive ETFs.
"I think they're a very interesting development," says Darren Coleman, senior vice-president and portfolio manager at Raymond James Ltd. in Toronto.
But is it a good trend? It depends on what a particular investor is looking to achieve, experts say.
In any case, active ETFs are increasingly pervasive. Bloomberg reported last month that assets in actively managed ETFs in Canada jumped to about $9.2-billion as of May 31, up almost 50 per cent from a year ago.
Active ETFs have also outperformed passive ETFs in Canada so far this year. Their percentage of the total ETF market is the highest among developed markets, making up about 11 per cent of Canada's $86.6-billion ETF industry.
By comparison, active ETFs make up only about 1 per cent of the United States' ETF market, which weighs in at $1.2-trillion (U.S.).
Actively managed ETFs differ from passive ones in that portfolio managers pick and trade stocks within the fund. Passively managed ETFs are constructed to follow the performance of a particular stock or bond index (usually referred to as a benchmark), with relatively low fees because they don't have managers buying or selling the securities they contain.
In theory, the advantage of having an active manager is that the manager reviews whatever is in the fund constantly and applies his or her expertise to make the most advantageous trades. The disadvantage is that this can drive up the fees for fund holders.
"The real issue here is cost," says Dan Bortolotti, investment adviser at PWL Capital Inc. in Toronto. While ETF fees can vary, they average around 0.5 per cent, with 1.5 per cent in the high range. Mutual fund fees can be as high as 2.5 per cent.
"Some actively managed ETFs charge less than 0.5 per cent – in fact, some in the United States are much cheaper," Mr. Bortolotti says.
"If you can get active management at extremely low cost, then at least you have a fighting chance at outperformance. But there are also active ETFs with costs well over 1 per cent, which puts them in the same fee bracket as many mutual funds," he says.
"Indeed, if the management fees are equivalent, mutual funds have many advantages over ETFs," he adds. For example, mutual funds can be bought and sold commission-free, with no bid-ask spreads. Investors can also set up their mutual fund portfolios so they can make automatic contributions and have dividends reinvested in the funds.
Yet while it may make sense to opt for an actively managed ETF in cases where the fees are relatively low, "I don't think the argument for active management is very compelling to begin with. That doesn't change just because the fund is an ETF rather than a traditional mutual fund," Mr. Bortolotti adds.
Mr. Coleman says that in addition to the relative costs, the dividing line for an investor should be not what the product is called but whether the investor and his or her adviser feel that having an active manager is a better fit for his or her portfolio.
"An ETF is just a structure. The ETF or the mutual fund is simply the box the investment comes in. Both structures have positives and negatives, just as passive and active strategies both have positive and negative attributes," he says.
Justin Bender, who works with Mr. Bortolotti as a portfolio manager at PWL Capital, agrees that overall strategy is more important than the investment vehicle.
"For most investors, success is not going to be determined by a specific product but by the financial planning and investment process they implement and adhere to," he says.
"Instead of focusing on the newest products being released into the marketplace, the majority of investors should start by putting a savings [or debt repayment] strategy in place, and determining how much risk they need to take with their portfolio."
Mr. Bender says that investors "should seek out the most broadly diversified, low-cost and tax-efficient securities. This will likely include some plain-vanilla ETFs and not likely any of the newer, flashier products."