How To Create An Active Etf

Funds like ETFs and mutual funds can help you build a diversified mix of investments. As the ETF market has evolved, different types of ETFs have been developed. They can be passively managed or actively managed. Passively managed ETFs attempt to closely track a benchmark (such as a broad stock market index, like the S&P 500), whereas actively managed ETFs intend to outperform a benchmark.

There are 2 types of actively managed ETFs—traditional actively managed ETFs and the recently approved semi-transparent active equity ETFs. Let's dig deeper into traditional actively managed ETFs.

Actively managed ETFs in focus

The underlying concept behind an actively managed ETF is that a portfolio manager adjusts the investments within the fund as desired while not being subject to the set rules of tracking an index—like a passively managed ETF attempts to do. The active fund manager aims to beat a benchmark using research and strategies. Traditional actively managed ETFs (as well as passively managed ETFs) report their positions daily and are priced throughout the day. This is one of the differences between an actively managed ETF and a comparable mutual fund.¹

Semi-transparent ETFs

Investors are seeing more choices after the SEC's 2019 approval of active semi-transparent ETFs that allow the fund manager to not disclose their full holdings daily, resulting in more of these types of ETFs being brought to market. This ruling applies to a specific set of products from a specific set of fund managers, and is not universal. Learn more about semi-transparent ETFs

Perhaps because portfolio managers generally do not want to divulge their next portfolio move for fear of front-running (i.e., a third party identifies and makes the same trade right before the fund executes its trade), actively managed stock ETFs have not proliferated to the extent of passively managed ETFs (see Semi-transparent ETFs sidebar).

Potential advantages and disadvantages of actively managed ETFs

It's important to understand the potential advantages and disadvantages of traditional actively managed ETFs before considering one of these investment choices. Advantages relative to some other investments include:

Potentially higher returns. Whereas a passively managed ETF attempts to track the performance of a benchmark, actively managed ETFs have the opportunity to outperform the benchmark through investment decisions by portfolio managers and research analysts. Of course, the fund might underperform the benchmark as well.
Potentially lower cost vs. comparable funds. The structure of an actively managed ETF can enable it to have lower expenses vs. a comparable mutual fund.
Tax efficiency. The share creation and redemption process can possibly result in ETFs being more tax-efficient than a comparable mutual fund because the process is done "in-kind," which is not a taxable event.²
Flexibility. Like index ETFs, actively managed ETFs allow investors to trade throughout the day, including short sales and buying on margin.³ This can also enable greater liquidity for ETFs relative to funds that do not trade throughout the day.

Of course, there are disadvantages to traditional actively managed ETFs. These include:

Daily disclosure requirement. This could be a problem for larger funds as well as funds that hold illiquid securities. Full disclosure might hinder an active manager's ability to make adjustments and implement a strategy with internal investment research in the portfolio, for fear of front-runners and other traders in the marketplace. Note that semi-transparent ETFs do not have this requirement.
Deviation from NAV. Traditional actively managed ETFs may develop large premiums or discounts to NAV on volatile trading days. These ETFs may develop premiums/discounts to NAV that are larger than those of passively managed ETFs.⁴
Higher costs vs. certain funds. Whereas actively managed ETFs may have lower costs relative to comparable mutual funds, they may have higher expense ratios compared with index-trading ETFs.

Next steps to consider

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ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.

2. ETF investors trade shares with other investors through the stock exchange instead of with the fund. As a result, many investor trades do not trigger transactions in the fund, which could result in capital gains. If an investor sells in a traditional open-ended mutual fund, the transaction is between the investor and the fund, which may create the need for the portfolio to sell securities to raise the cash needed to meet the redemption, which may trigger a capital gain for all the mutual fund's shareholders.

3. Certain ETFs are not marginable until 30 days from settlement.

4. An ETF that is trading at a premium has a market price higher than its NAV; therefore, an investor would pay more for the ETF than its holdings are actually worth. If an ETF is trading at a discount, its market price is lower than its NAV, so the investor would buy the ETF for less than the value of its holdings.

ETFs are subject to market volatility and the risks of their underlying securities which may include the risks associated with investing in smaller companies, foreign securities, commodities and fixed income investments. Foreign securities are subject to interest rate, currency- exchange rate, economic and political risk all of which are magnified in emerging markets. ETFs that target a small universe of securities, such as a specific region or market sector are generally subject to greater market volatility as well as the specific risks associated with that sector, region or other focus. ETFs which use derivatives, leverage, or complex investment strategies are subject to additional risks. The return of an index ETF is usually different from that of the index it tracks because of fees, expenses and tracking error. An ETF may trade at a premium or discount to its Net Asset Value (NAV). The degree of liquidity can vary significantly from one ETF to another and losses may be magnified if no liquid market exists for the ETF's shares when attempting to sell them. Each ETF has a unique risk profile which is detailed in its prospectus, offering circular or similar material, which should be considered carefully when making investment decisions.

Margin trading entails greater risk, including, but not limited to, risk of loss and incurrence of margin interest debt, and is not suitable for all investors. Please assess your financial circumstances and risk tolerance before trading on margin. Margin credit is extended by National Financial Services, Member NYSE, SIPC.

Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.

Investment decisions should be based on an individual's own goals, time horizon, and tolerance for risk.

Past performance is no guarantee of future results.

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