Exchange-traded funds (ETFs) have become increasingly popular among both institutional and retail investors over the years due to their unique characteristics such as diversification, liquidity, and cost efficiency (To learn more about the product features of ETFs and the differences to mutual funds, please read the article: “What is the difference between mutual funds and ETFs”). While most traditional ETFs are passively managed, the rise of actively managed ETFs has added another layer of appeal, expanding the investment options available. These actively managed ETFs combine the structural advantages of ETFs with the potential for outperformance through active management (To learn more about the differences between actively managed and passive ETFs please read the article: “What are the differences between active and passive ETFs”).
Both passive and active ETFs offer instant diversification. Traditional ETFs usually track a broad market index like the S&P 500, providing exposure to a wide array of companies or assets. This is advantageous for institutional investors managing large portfolios, as they can achieve wide-reaching diversification with minimal transactions. Retail investors, too, benefit from access to diversified portfolios without the need for significant capital or individual stock picking.
Actively managed ETFs take this a step further. Instead of merely tracking an index, they allow professional fund managers to actively make investment decisions within the portfolio. The specific investment strategy of a portfolio manager can potentially lead to better risk adjusted returns or general outperformance, which is appealing to institutional investors looking for specific management strategies to gain a performance edge over their benchmarks. Retail investors can access the expertise of active management without the higher costs or limitations often associated with traditional mutual funds.
Since ETFs offer a wide array of investment opportunities because the available asset classes and investment strategies ranging from plain vanilla market indices to sector-specific ETFs and alternative assets such as commodities, precious metals, or even hedge fund-like strategies, institutional investors like to use ETFs as building blocks to implement their investment strategies. That said, this use case is also an applicable option for retail investors who want to tailor their portfolios to their market expectations. With regard to this, it is noteworthy that such a strategy bears, especially for retail investors, also the risk of an underperformance as investors may miss a fast market rotation and/or buy a complex alternatives product unsuitable for their portfolios.
Active ETFs further enhance this array of investment opportunities by giving investors access to professional managers who can adjust the portfolio based on market conditions, economic trends, or company-specific factors. For institutional investors, active ETFs provide an additional tool to generate alpha, pursue specific strategies, or react to market changes more nimbly than passive investments. That said, institutional investors may fail to reach their investment goals if the active ETF does not beat its benchmark. Retail investors, who may not have the time or expertise to actively manage their portfolios, can benefit from the active decision-making capabilities of a professional fund manager without having to pay the higher fees typically associated with mutual funds.
With regard to the above, ETFs—including the rising category of actively managed ETFs—are highly appealing to both institutional and retail investors due to their liquidity, transparency, cost efficiency, and diversification. While passive ETFs offer a simple and cost-efficient way to invest in broad markets or specific market segments, actively managed ETFs provide additional opportunities for outperformance through professional management while retaining the benefits of liquidity and accessibility. This combination of features is the main reason why ETFs are highly attractive investment vehicles for all kinds of investors, regardless of their level of sophistication or capital size.
This article is for information purposes only and does not constitute any investment advice.
The views expressed are the views of the author, not necessarily those of LSEG Lipper or LSEG.
