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Active ETFs and other new alternative funds are being launched faster than investors can keep track of. Is this a positive trend that could prove to be useful for strategic investors, or might it be a money-making marketing ploy on the part of fund companies and brokerage firms?
I recently wrote a story here about smart beta funds, which I said were like “index funds that weight their holdings in some strategic form that is different than the conventional cap-weighting of traditional index funds. In simple terms, smart beta funds are passive index funds with an actively-managed twist.”
These active exchange-traded funds with indexing qualities come in several different varieties, which are usually focus on a particular weighting strategy, dividend strategy or volatility strategy.
I also recently wrote about low-volatility ETFs, which I noted “will seek to hold a number of securities – usually from a benchmark index – that are less volatile in relation to other securities in the index.”
And last summer I reported on a new fund alternative called an ETMF, or exchange-traded managed fund, which falls somewhere between ETFs and actively managed open-end mutual funds. ETMFs are an Eaton Vance (NYSE: EV) creation that they call “NextShares.” At the time, I said, “Like ETFs, these ETMF shares can be bought and sold in real time during the trading day. But like mutual funds, they won’t actually price until after the close at net asset value (NAV). This is called ‘NAV-based trading.'”
Active ETFs: Is the Trend Your Friend?
Just last month, Franklin Templeton Investments (NYSE: BEN) announced that a new trio of active ETFs, as well as a set of smart beta funds, will be made available to investors.
Please forgive the skepticism, but it seems that fund companies are looking to capitalize on a trend in bringing new ETFs to the market that may not really be anything new. At a minimum, the lines between passive and active ETFs are becoming increasingly blurred.
For example, one of the new ETFs being launched by Franklin Templeton will be a low-volatility ETF, which is benchmarked against the Russell 1000 Index. Although the fund won’t exactly track the index like a traditional index fund or ETF, it will hold stocks within the index that are less volatile in relation to other stocks in the index. This strategy can be considered passive management with an active twist.
While on the surface the idea of active ETFs sounds appealing, this new breed of fund doesn’t have a long track record to measure its worth. Therefore, it’s not clear as of yet whether or not active ETFs are a good idea, or if they are repackaged index funds with appealing names and nuanced strategies.
The bottom line is that investors need to pay more attention to ETFs now than ever before. Until recently, the acronym ETF was completely associated with passive indexing. Now investors need to do a bit more digging than before to be confident they fully understand how active ETFs are investing. The words “active” or “smart beta” won’t often be included in the fund name.
Furthermore, there’s not enough evidence to date that can prove that active ETFs make more sense to hold than a well-managed low-cost mutual fund.
At best, active ETFs appear to have potential as a smart alternative to passive ETFs and index funds. At worst, they are a marketing ploy that will turn into a poor performance trap for investors.
Kent Thune is the owner of an investment advisory firm in Hilton Head Island, S.C. He personally does not hold any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.