What Are Actively Managed ETFs? How Do They Work?

Exchange-traded funds (ETFs) have revolutionized the investment landscape, offering a wealth of low-cost, flexible, and transparent options to even novice investors to effortlessly tap into real-time market trading. But wait, there's more––enter actively managed ETFs. 

These aren't your ordinary ETFs. In fact, they're supercharged with the acumen of fund managers who actively make strategic decisions to outwit the market. With a mission to surpass their passive peers, these funds blend the best of both worlds: the broad diversification of ETFs and the nimble, expert touch of active management.

In this guide, we'll explore the ins and outs of actively managed ETFs, including how they operate, their key features, and whether they could be the missing piece in your strategy.

What are actively managed ETFs?

Actively managed ETFs represent a distinct, relatively low-cost means of portfolio diversification. They also increase the potential of earning market-beating returns on investment (ROI). That’s because these funds have professional money managers or money management teams selecting the assets, making buying and selling decisions, and generally running the show. 

In some ways, it’s like getting a mutual fund for an ETF’s cost. This makes actively managed ETFs increasingly popular––so popular that they now represent millions and billions of dollars.

Examples of popular, large active ETFs include Fidelity’s Blue Chip Growth ETF and Pimco’s Active Bond ETF (BOND), which consistently rank as some of the most popular vehicles in the category. Another example is JP Morgan’s Equity Premium ETF (JEPI), which counts more than $28 billion in AUM (at the time of writing).

(Check out ETFs like PDBC, ROE, and AGOX on Composer, and start executing trades today.) 

How do actively managed ETFs work?

Actively managed ETFs typically contain a diversified asset portfolio—which could include stocks, bonds, commodities, or even cryptocurrency—selected by a professional money manager or money management team.

However, the service doesn’t stop at mere selection. The defining characteristic of actively managed ETFs is a commitment to ongoing research, adjustment, and optimization. Portfolio managers aim to stay vigilant, tracking market conditions, economic trends, news from the Fed, and the performance of individual companies.

Such managers may regularly modify the fund's holdings, seeking to capitalize on growth opportunities and react to changes in the market. This active and strategic approach allows investors to ride the tides of market changes while benefiting from expert guidance. However, the picture isn’t all rosy.

Pros and cons of actively managed ETFs

Actively managed ETFs present distinct advantages, offering a unique approach to investing and blending the benefits of ETFs with active portfolio management. But they also come with a couple of downsides, and weighing them makes decision-making easy. 

Here's a look at the pros and cons of actively managed ETFs:

Pros of actively managed ETFs

Potential for outperformance

Like mutual funds, actively managed ETFs are designed with a clear objective: to outperform their benchmarks. The driving force behind this potential outperformance is the expertise of professional portfolio managers, who attempt to capitalize on market inefficiencies that can lead to better returns for investors. But remember, they’re not always successful in the attempt.

Active risk management

The dynamic nature of actively managed ETFs extends to risk management. Portfolio managers actively monitor market conditions and swiftly adjust fund holdings as needed. This flexibility allows them to implement risk mitigation strategies during market downturns, economic shifts, or geopolitical events. 

Especially during market turbulence, this active approach can help protect an investment’s value, potentially leading to smoother returns and reduced downside risk.

Adaptability

Unlike passively managed ETFs, which follow common market indices like the S&P 500 or Dow Jones to replicate their performance, actively managed ETFs aren’t locked into a fixed strategy dictated by a market index or sector. This adaptability can be a significant advantage, as it enables the fund to quickly adjust and adapt to market movements.

Cons of actively managed ETFs

Higher costs

The nature of active management––including research, analysis, and portfolio adjustments––typically leads to higher expense ratios than passive management. Over the long term, these costs can impact the overall ROI. This is especially prominent in lower-yield environments and bear markets, where even the last percentage point matters.

Potential underperformance

Active management is not necessarily an advantage all the time. But why? The pursuit of outperformance doesn’t always yield the desired results, which is why many actively managed funds fail to consistently outperform their benchmark indices. 

Here, investors can find themselves paying higher fees for professional management without piling up superior returns. This makes the trade-offs between active and passive management an essential consideration for investors.

Lack of transparency

In some instances, actively managed ETFs may lack transparency and may not disclose their holdings as frequently or as transparently. This limited transparency can be a drawback for investors who value visibility into their investments. A lack of real-time insight into the fund's holdings makes it more challenging to track and assess the performance and strategy of the ETF.

How to invest in actively managed ETFs with Composer

Whether looking at actively or passively managed ETFs, Composer can be your stepping stone. With Composer, trading ETFs is simpler and easier than ever before. Our versatile platform combines sophisticated investment strategies with user-friendly features to empower both novice and experienced investors.

Even better, signing up is easy. Simply follow the steps below:

1. Sign up to Composer for free

Your investing journey begins with a few easy clicks. Get started by signing up for Composer's 14-day free trial. Create your account to gain access.

2. Head to "Create a New Symphony"

Once you've signed up and logged in, you're ready to dive into ETFs and other investment vehicles. 

Look for the "Create" button on the top left corner, and click to reveal a dropdown menu. Next, select "+ New Symphony"––this is your gateway to building your investment strategy.

3. Use the AI tool and no-code editor to create a symphony

Composer offers you two powerful tools for crafting your ETF investment strategy (or any other kind of strategy). You can choose the "Create with AI" option to open a chat with the AI tool. This AI-driven feature simplifies the strategy-building process, making it accessible for all investors, regardless of their level of experience or coding knowledge.

Begin by discussing your investment goals and preferences with the AI tool. For example, you can specify that you're interested in actively managed ETFs and outline your risk tolerance and time horizon. The AI tool will then generate a strategy aligned with your objectives.

If you prefer a more hands-on approach, Composer's platform also includes a no-code editor. This editor allows you to fine-tune your investment strategy with complete control. Adjust your allocation to actively managed ETFs and tailor the rebalancing frequency to your liking. The strategy will automatically maintain equal weights in each of your chosen ETFs, ensuring a diversified and risk-balanced approach.

Begin your trading journey with Composer

With Composer, investing in actively managed ETFs becomes a straightforward and enjoyable experience. Whether you're a seasoned investor or just learning the ropes, you’ll find the tools to make informed decisions, manage your money, and create and execute strategies based on your financial goals.

Head to composer.trade, and get started today.