Hands on or hands off?
When it comes to exchange-traded fund (ETF) investing, it would appear Canadian investors are increasingly gravitating to hands-on, actively managed ETFs. From a standing start just over eight years ago, almost 30% of total ETF assets under management (AUM) in Canada are now actively managed. From a product perspective, almost half of the nearly 1,500 ETFs available are now actively managed.
Gaining traction
Active vs. passive ETF assets under management and market share
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Source: Morningstar, as of August 31, 2024
Active vs passive ETFs
Actively managed ETFs share many of the same capabilities as passive index-tracking ETFs — intraday trading, liquidity and cost efficiency — but with some key differences. Active ETFs give the portfolio manager the flexibility to diversify away from certain securities that may be a large part of the index or to hold issuers with no, or a much smaller footprint in the index to seek better, more targeted outcomes for investors. The following table highlights the features of both active and passive ETFs.
Features |
Active ETFs |
Passive ETFS |
|---|---|---|
Management Style |
Actively managed by portfolio managers who make investment decisions based on research and analysis. |
Passively managed to replicate the performance of a specific index or benchmark. |
Objective |
Aims to outperform a specific index or benchmark, or to provide a more targeted outcome. |
Aims to match the performance of a specific index or benchmark. |
Cost |
Generally higher due to active management fees. |
Generally lower due to minimal management involvement. |
Flexibility |
Can adjust investment exposures in response to market conditions. |
Limited to the composition of the index they track, with little flexibility to adjust. |
Transparency |
Less transparent as holdings can change based on day-to-day investment decisions. |
More transparent as holdings are usually disclosed daily. |
Examples |
Actively managed equity or bond funds. |
Index funds, such as those tracking the S&P 500. |
Types of active ETFs
Due to the proliferation of active ETFs, investors can choose from a large number of varieties covering virtually all asset classes: stocks, bonds, commodities and more; beyond asset classes, one important distinction is between “core” and “satellite” exposures.
Core
As the name suggests, core active ETFs are designed to be foundational in nature. They generally account for the largest portion of an investor’s portfolio. Examples of core active equity funds are those that invest globally, internationally or in a specific country such as Canada or the U.S, sourcing investment ideas across a large part of that particular market. Similarly, a core active bond fund would invest globally and/or in a targeted mix of specific bonds.
Satellite
Satellite actively managed ETFs are designed to complement core investments and are more focused in nature, typically investing in a market sector (health care), an industry (semiconductors) and/or a market theme (artificial intelligence). Other satellite examples would be those that invest in commodities and/or use complex strategies in an effort to boost results (leveraged and inverse ETFs).
How to invest in active ETFs
Active ETFs are bought and sold through an exchange at the current market price, similar to how stocks are traded. When you buy units of an active ETF, you do so through a brokerage account, and the transaction occurs at the market price. The units are not individually redeemed from the fund; instead, they are traded among investors on the exchange which allows for intraday trading. Unit creation and redemption in the primary market ensures that the market price closely reflects the fair value of the underlying holdings.
Trading basics
At any given time during market hours, there are two prices for an ETF. The price an investor is willing to pay, the bid, and the price at which an investor is willing to buy, the ask. The following is designed to give you the basics when it comes to trading ETFs.
Market vs. limit orders
When buying or selling ETFs, investors can choose between market and limit orders. Market orders buy and sell at the current price, which is ever-changing throughout the day. In exchange for receiving the current price whatever it may be, investors can generally be confident the transaction will be completed, or “filled”. In contrast, investors can set a maximum and minimum price at which they’re willing to complete the transaction. This is called a limit order. Keep in mind, limit orders may not be filled due to your pre-selected prices, so it’s important to double-check to see if the transaction has occurred.
When to trade
When trading ETFs, the general rule is to avoid doing so during the first and last 15 minutes of each day markets are open. The reason lies in price volatility. There are simply more ups and downs in price movements at the start and end of the day. This may lead to a price surprise if placing a market order, while a limit order is generally less likely to be filled.
Be mindful of intraday volatility
During times of market stress, it’s more likely there’ll be a greater difference between the bid price and the ask price, which is referred to as the “spread”. When trading during these periods, investors may want to pay close attention to the bid-ask spread to determine how “wide” it is to, once again, avoid a potential price surprise.
Active ETFs and portfolio building
With an abundance of choice, active ETFs are helpful building blocks to complement or build an entire, all active portfolio. If it’s the latter, a key question for investors is how much of each active ETF to include in terms of percentage weight in the portfolio. How much equity, how much fixed income and how much specialty? The process of doing so is called asset allocation and investors who may be unsure how much of each to invest in should consult an advisor.
Capital Group has four actively managed ETFs designed to strengthen the core of a portfolio.