Actively Managed ETF

An actively managed ETF is an exchange-traded fund whose portfolio is chosen by a manager rather than assembled to match an index. It trades on an exchange through the day, issues and redeems shares in creation units with authorized participants, and is a registered investment company, exactly like an index-based ETF. The only difference is the objective: instead of matching a benchmark, the manager is trying to do something else with the same wrapper.

The SEC uses the phrase itself and, in its 2019 ETF rulemaking, gave it a scoped meaning worth knowing about: for the purposes of that release, the SEC said it used "actively managed ETFs" to refer to actively managed ETFs that provide daily portfolio transparency, and "non-transparent ETFs" to refer to actively managed ETFs that do not. That is a definition written for one document rather than a general one, but it marks the line that matters most in practice, because daily transparency is what the rule requires.

The regulatory answer is that the wrapper does not care what the manager is doing. Rule 6c-11 provides exemptions for both index-based and actively managed ETFs and, in the SEC's own words, "will not by its terms establish different requirements based on whether an ETF's investment objective is to seek returns that correspond to the returns of an index". The reason given is operational: index-based and actively managed ETFs that comply with the rule's conditions "function similarly with respect to operational matters, despite different investment objectives or strategies", because both register under the Act, both issue and redeem shares in creation unit sizes in exchange for baskets of assets, both list on national securities exchanges, and both let investors trade through the day at market-determined prices.

The separation that used to exist was history rather than principle, and the SEC says so. The distinction in the older exemptive orders "is largely a product of ETFs' historical evolution", because the SEC "did not approve the first actively managed ETF until nearly 15 years after index-based ETFs were introduced". Since 2008 the market grew considerably, the SEC watched how these funds operated, and it "has not identified any operational issues that suggest additional conditions for actively managed ETFs are warranted".

Daily portfolio transparency is the condition, and it is specific. Rule 6c-11(c)(1)(i) requires an ETF, each business day and before the opening of regular trading on its primary listing exchange, to disclose prominently on a free public website, for each portfolio holding that will form the basis of the next net asset value calculation: the ticker symbol, a CUSIP or other identifier, a description of the holding, the quantity held, and the percentage weight of the holding in the portfolio. Those holdings must be the fund's holdings as of the close of business on the prior business day. For a manager whose value is supposed to lie in what they have worked out before anyone else, publishing the whole position list every morning is a real cost, and it is the price of using the rule.

That cost is exactly why the non-transparent category exists. In 2019 the SEC granted an exemptive order permitting certain actively managed ETFs to operate without being subject to the daily portfolio transparency condition included in other actively managed ETF orders. The release records the consequence in one sentence: "because these non-transparent ETFs do not provide daily portfolio transparency, they would not meet the conditions of rule 6c-11". They are not a milder version of the same thing; they are a separate arrangement operating under their own relief, and the trade-off they make is protection of the strategy in exchange for showing holders less.

What does not change is worth listing, because it is most of the product. The creation and redemption machinery, and the arbitrage that keeps the market price close to net asset value, work the same way regardless of what the manager is doing, and depend on the same authorized participants. The bid-ask spread is still a cost of every trade. The in-kind mechanism that makes the ETF wrapper unusually tax-efficient in a taxable account is a feature of the structure, not of the strategy. And the question of whether active management earns its fee is entirely unaffected by which wrapper it arrives in; our page on active management sets out the evidence, and the arithmetic of the cost difference belongs with index funds. A cheaper wrapper for an expensive strategy is still an expensive strategy.

The fund registers as an investment company, lists on an exchange, and appoints authorized participants who create and redeem shares in blocks against baskets of assets. The adviser buys and sells holdings in pursuit of the stated objective. Each business day, before regular trading opens, the fund publishes its full holdings list on a public website, along with the previous day's net asset value, market price and premium or discount. An investor buys and sells shares on the exchange like any other listed security.

A hypothetical showing what the disclosure condition actually costs a manager. Assume an actively managed ETF has $500 million in assets and its manager decides to build a 3 percent position in one company, or $15 million of stock. Buying that in one morning would move the price, so the desk works the order over ten trading days at roughly $1.5 million a day ($15 million divided by 10). Every one of those mornings, the fund publishes the position and its weight, so the market watches the holding go from 0.3 percent ($1.5 million divided by $500 million) to 0.6 percent, and on up to 3.0 percent, one disclosure at a time. Nothing about that is a defect in the rule; it is the transparency the rule requires, and it is the reason some managers took a different route and accepted operating outside the rule instead.

Pros

• Full daily holdings disclosure, which is more than a comparable mutual fund publishes, so a holder can see exactly what they own each morning.
• The ETF wrapper's ordinary advantages apply: intraday trading, low minimums, and the in-kind creation and redemption mechanism that makes ETFs unusually tax-efficient in taxable accounts.
• No separate regulatory regime to learn. The same rule, the same conditions and the same website disclosures apply as for an index ETF.
• Gives access to strategies that would otherwise require a mutual fund minimum or a separately managed account.

Cons

• Wrapping an active strategy in an ETF does nothing to the strategy. The long-run evidence on active management, which our page on active management sets out, applies unchanged.
• Costs are higher than a comparable index ETF, and the fee is charged whether or not the manager's judgment adds anything.
• Daily disclosure of holdings can work against the fund's own investors, because the market can see a large position being accumulated or unwound.
• Non-transparent variants avoid that problem by showing holders less, which trades one disadvantage for another and puts the fund outside the ETF rule's conditions.
• A newer or smaller active ETF can trade with a wide bid-ask spread, so the cost of getting in and out is a real part of the total.