How to Invest in Active ETFs

What is an active ETF?

Investors are reaping the benefits of a boom in active ETFs, or actively traded Exchange Traded Funds. Active ETFs combine ETF benefits—low-cost, diversified, flexible—with the hands-on approach of a fund manager buying and selling stocks and/or bonds to try to outperform the market and generate higher returns for investors.

In today’s market, investors have their pick of actively managed ETFs, each with a particular focus on various stocks, bonds, currencies, commodities, industries, and different regions, or a mix of all of the above, to name just a few.

On Magnifi, investors can search “invest in active ETFs,” look for active ETFs to match their passions from robotics to Iceland, and even quickly research the proportion of actively managed shares that an active ETF holds.

ETFs 101

An Exchange Traded Fund (ETF) is like a grocery basket of various stocks and bonds, with shares sold on the stock exchange. Active or passive, ETFs are traded on an exchange like a stock. Yet these funds are comprised of shares of many stocks and bonds, like a mutual fund.

As such, an ETF is a low-cost and tax-efficient option to invest in a variety of asset classes and investment strategies. ETFs tend to have lower annual expenses than mutual funds, but due to the fact that they are traded like stocks, they come with higher transaction costs such as commissions, bid-ask spreads, and other fees.

Active ETFs

Most Exchange Traded Funds are passive, meaning they track an index such as the S&P 500 or the Nasdaq. Active ETFs are only a small part of the $7 trillion ETF industry in the U.S., about 10.5 percent of sales and 4 percent of total assets. However, 2021 saw for the first time the launch of more active ETFs than passive ETFs—about 60 percent of the 500 ETFs that year.

This phenomenal growth is driven by enthusiasm among institutional investors: 78 percent of institutional investors prefer ETFs to other index vehicles, up from 68 percent in 2021.

One example of an actively managed ETF is the JPMorgan Equity Premium Income ETF (JEPI), which is an actively managed fund with rapidly growing popularity. The fund seeks to generate income while maintaining prospects for capital appreciation. The managers of this fund seek to achieve this objective by accomplishing the following:

Creating an actively managed portfolio of equity securities comprised significantly of those included in the fund's primary benchmark, the Standard & Poor's 500 Total Return Index (S&P 500 Index)
And through equity-linked notes (ELNs) and selling call options with exposure to the S&P 500 Index.

Another option that is gaining popularity among investors is the Dimensional US Core Equity 2 ETF (DFAC). The funds' investment strategy seeks to achieve long-term capital appreciation while considering federal income tax implications of investment decisions. The fund is designed to purchase a broad and diverse group of securities of U.S. companies.

As a non‑fundamental policy, under normal circumstances, the fund will invest at least 80% of its net assets in securities of U.S. companies. The managers of the fund can also purchase or sell futures contracts and options on futures contracts for U.S. equity securities and indices, to increase or decrease equity market exposure based on actual or expected cash inflows to or outflows from the portfolio.

This active management strategy is what sets these funds apart from an ETF like the SPDR S&P 500 ETF Trust (SPY), which has a much more passive investment strategy.

What makes active ETFs so popular?

No minimum costs: Actively managed ETFs do not require a minimum investment. This is unlike mutual funds, the other actively managed asset that investors invest in, which demand an initial outlay that can run into the thousands of dollars.
An investor can buy a single share or fraction of a share of an ETF, allowing them to add an actively managed investment to their portfolio for as little as $1.
Many brokerages now offer commission-free trading, which makes ETFs even more affordable and accessible. However, investors should be alert to fees and commissions associated with active ETFs.

You don't need to be an expert to invest.

Tax advantages: Unlike traditional mutual funds, ETFs are often more tax-efficient because they are index funds. These have fairly low turnover and so provide less chance to realize gains when stocks or bonds are sold.
Shares of ETFs are created and destroyed through in-kind transactions that take place between the fund’s sponsors and an organization called an authorized participant. Due to this setup, ETFs don’t usually have to directly sell positions from their portfolios to meet redemptions—thus avoiding taxable capital gains distributions.
Rapid risk management: World events can upend markets, and ETFs are a good tool to actualize specific changes without a lot of hassle. Other characteristics of ETFs, such as execution speed, single-trade diversification, and liquidity, are also helpful in mitigating risk.
Versatility: ETFs’ phenomenal versatility can be applied to a wide range of strategic and tactical goals. Institutional investors tend to prefer ETFs for factor-based and other specialized exposures.
Downside protection: ETFs combine the potential for high returns with robust downside protection, which many investors look for during uncertain economic times. Active management can be key to downside protection, and active ETFs are an affordable and accessible option for investors.

Why invest in active ETFs?

Investors invest in active ETFs to take advantage of a fund manager or management team's expertise, diversify their investments, and manage risk.

There are several key ways that investors take advantage of active ETFs. If you have a financial advisor, you can ask them how to use active ETFs to help you meet your financial goals. If you are investing on Magnifi, you can ask your virtual assistant how to invest in active ETFs.

Active ETFs can help you invest for the long-term in 6 ways:

Get strategic. Tweak your portfolio by investing in active ETFs to increase or reduce exposure to certain sectors, regions, countries, and more.
Focus on the long-term. Bolster your portfolio with a strategic allocation of a long-term investment like an ETF.
Reduce risk. Because ETFs include a variety of assets with exposure to different regions and industries, adding an ETF to your portfolio is an efficient way to help you reduce risk.
Stay balanced. When it comes time to review your portfolio and your financial plan, ETFs are an efficient way to help you round out and balance your investments.
Keep diversified. ETFs with exposure to global markets make it easier to diversify your investments.
Cash flow. ETFs have more liquidity than mutual funds, so if you need cash, you can get it more easily.

Wise investors look at the pros and the cons of active ETFs.

Pros

Investors usually don’t need to meet a minimum to invest in an active ETF.
Many brokerages offer commission-free trading, making ETFs affordable and accessible.

Cons

Active management does not necessarily translate to higher returns.
Active ETFs charge higher fees than passive ETFs, regardless of performance.

How to invest in active ETFs.

Investors can invest in actively managed ETFs for any investment strategy that they have, with different allocations of stocks, bonds, currencies, commodities, industries, and different regions. On Magnifi, investors can search for active ETFs that match their strategies, their passions, or their financial goals.

References:

Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
Noblett, Jackie, “Debuts in active ETFs surge as US investors’ appetite grows,” December 31, 2022, Financial Times, link.
McNinch, Shawn, and Ryan Sullivan, Antonette Kleiser, and Chris Pigott, “2022 Global ETF Investor Survey,” March 15, 2022, Brown Brothers Harriman, link.