Actively Managed Funds Explained

Actively managed funds are a type of investment vehicle where a professional fund manager or team actively selects and manages the underlying assets to achieve specific investment objectives. Unlike passively managed funds, which aim to replicate a particular index or sector, actively managed funds seek to outperform their benchmarks through strategic investment decisions.

What Are Actively Managed Funds?

Actively managed funds are overseen by experienced fund managers who use their expertise and research to make informed investment decisions. These funds can be found in both mutual funds and exchange-traded funds (ETFs). The primary goal of an actively managed fund is to deliver returns that exceed the market average, although there is no guarantee of success.

Key Characteristics of Actively Managed Funds

1. Active Management: The fund manager or team actively selects and manages the portfolio, making decisions based on market analysis, financial forecasting, and their own experience.
2. Benchmark-Beating Potential: Actively managed funds aim to outperform their benchmarks, such as the S&P 500 or other market indices.
3. Flexibility: Fund managers can adjust the portfolio as needed to respond to changing market conditions, which can be particularly beneficial during times of high volatility.
4. Intraday Trading: Like ETFs, actively managed ETFs allow for intraday trading, providing greater liquidity and flexibility for investors.
5. Lower Expense Ratios: Many actively managed ETFs have lower expense ratios compared to their mutual fund equivalents, making them a cost-effective option for investors.

Advantages of Actively Managed Funds

Due to their active management style, these funds offer several potential advantages:

1. Potential for Higher Returns: By actively selecting securities, fund managers can potentially deliver higher returns than passively managed funds.
2. Professional Expertise: Investors benefit from the expertise of seasoned financial professionals who continuously monitor and adjust the portfolio.
3. Tax Efficiency: The share creation and redemption process in ETFs can result in tax efficiency, as these transactions are typically done "in-kind," which is not a taxable event.
4. Flexibility in Portfolio Management: Actively managed funds allow for greater flexibility in managing risk through hedging strategies and sector allocation adjustments.

Disadvantages of Actively Managed Funds

While actively managed funds offer potential benefits, investors should be aware of the associated drawbacks:

1. Higher Costs: Actively managed funds often come with higher expense ratios compared to passively managed index ETFs, which can eat into returns.
2. Risk of Underperformance: Despite the potential for higher returns, many actively managed funds underperform their benchmarks, which can be a significant drawback.
3. Higher Turnover Ratio: Actively managed funds tend to have higher turnover ratios, which can result in more capital gains taxes for investors.
4. Diversification Challenges: The dynamic nature of actively managed funds can sometimes lead to less diversified portfolios, as managers may shift allocations frequently in response to market conditions.

Trends in Actively Managed ETFs

The actively managed ETF space has seen significant growth in recent years. As of the end of 2023, there were approximately 1,255 actively managed ETFs in the U.S., managing around $444 billion in assets. This represents about 20% of all ETFs and accounts for about $530 billion of the $9.6 trillion ETF space. Notably, the assets under management (AUM) for active ETFs increased by 55% over the previous year, with about 73% of all new ETFs launched in 2023 being actively managed.

Examples of Successful Actively Managed ETFs

Several actively managed ETFs have demonstrated notable success, attracting significant investor interest:

1. ARK Innovation ETF (ARKK): This ETF, which focuses on "disruptive innovation," surged 71% in 2023. It holds companies at the forefront of technological and scientific advancements, including DNA technology firms, industrial innovators, next-generation Internet companies, and fintech service providers.
2. JPMorgan Equity Premium Income ETF: This fund was the top performer in 2023 in terms of cash flow, drawing $12.9 billion of capital.

Conclusion

Actively managed funds offer a dynamic approach to investing, leveraging the expertise of professional fund managers to potentially outperform market benchmarks. While they come with higher costs and risks of underperformance, they also provide the flexibility to adapt to changing market conditions and the potential for higher returns. As the actively managed ETF space continues to grow, it is essential for investors to carefully evaluate the benefits and drawbacks of these funds to determine if they align with their investment goals and risk tolerance.