There has to be much laughter on Bay Street about one of the hot exchange-traded fund trends of the past year.
Actively managed ETFs were so hot they took in larger inflows of money than passive index-tracking funds in many months of 2023, according to TD Securities. What makes this trend notable is that active ETFs account for only 24 per cent of Canadian ETF assets, compared with 67 per cent for passive index-trackers and 17 per cent for high-interest savings ETFs used to park cash.
The ETF industry was built on the idea of taking money away from high-fee, actively managed mutual funds by offering ultralow-cost funds tracking the world’s notable stock and bond indexes. Investors in ETFs used to be aggressive believers in passive investing, and militantly against the idea of handing money to a team of Bay Street portfolio managers. Now, those same active managers are the ones powering growth in ETF assets.
The rise of active ETFs is about the ETF industry’s need to find ways to entice investors and build assets. Competition to cut fees on basic index-tracking funds has quieted down, and there aren’t any serious indexes that haven’t already been used to develop funds. Active ETFs offer a new frontier of products for people who think passive investing is boring and deprives them of the chance for index-beating returns.
Excellent stock market returns lately make investors receptive to the idea of active management. And, let’s be honest, active management has a better chance of beating the index if it costs less. The fees on active ETFs are much cheaper than those of traditional mutual funds, although they’re not much lower than the Series D mutual funds targeted at DIY investors.
Still, decades of experience with mutual funds shows how fallible portfolio managers are. It’s a done deal that some investors buying active ETFs are going to be disappointed they didn’t just buy an index-tracker.
If you’re looking at an active ETF, compare its returns with those of a passive index-tracking fund in the same category. Comparisons over one or two years have minimal value, but they’re the best you’re likely to get for many active ETFs because they’re still a fairly new category. A five-year comparison is ideal because it includes big ups and downs in financial markets over that period.
Look for consistency of returns with active management. One of the traps investors fall into with active management is being lured in by one or two index-trouncing years. These numbers make a bold statement on their own, and they inflate longer-term numbers as well.
TD says the trend of growth in active ETFs outpacing index-tracking funds is likely to continue in 2024 as more active fund managers launch ETFs. Suggestion: Let these new active funds build a track record before taking a look.
Rob Carrick