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This episode aired on BloombergTV on Dec 17, 2012

Actively Managed ETFs

Actively managed exchange traded funds are, much like their passively managed bretheren, tradeable on stock exchanges and comprised of an underlying basket portfolio of stocks. Passively and Actively Mananged ETFs differ in how those underlying baskets are chosen- the former generally track an index while the later relies on a manager to pick and choose investments.

Q. So this is a growing area of ETF land, but… the very idea of “actively managed” seems a bit at odds with the basic idea of ETFs, doesn’t it?

A. Well, yes. The big idea of ETFs has been that they’re passively managed, and invest in a very specific set of securities, like the S&P 500. Investors know exactly what they’re buying, which allows them to diversify very well, and the low turnover rate of the stocks also means they’re tax efficient. That basic idea has worked awful well, and the ETF industry has grown to ZXY.

Q. So, what’s the idea of “actively managed” ETFs, then?

A. Well, pretty much what it sounds like: instead of following an index, there’s a manager who decides what securities will be in the ETF basket. So, back to the future: it suddenly looks a lot like a regular mutual fund, except for one big thing: you can trade an ETF at any time during the day, like a stock; but mutual funds are redeemed out at the end of each day.

Q. And is that a big difference? Should investors care about that?

A. Regular investors should not care. In principle, they’re in for the long haul… funnily enough, many folks think that the intra-day trading feature of an actively managed ETF is a negative, because it encourages retail investors into expensive trading patterns. But of course for the pros, intraday trading is a crucial feature.

Q. And how about the fee differences between active ETFs, passive ETFs, and mutual funds?

A. This is a key point. People think about ETFs as inherently cheaper than mutual funds, and nearly all traditional ETFs do have lower fees (but note you do pay brokerage commissions on buying and selling ETFs, but do not pay those with no-load mutual funds). But what people need to understand about actively managed ETFs is that you can pay more in management fees than you do with mutual funds…

Q. Bottom line?

A. For retail investors, there’s almost no real difference between actively managed ETFs and regular mutual funds. So it’s all about quality of manager and total fees, which you should not assume the actively managed ETF has some huge advantage from that point of view.