When Active ETFs Aren't Really Active

Regardless of the marketing name du jour for these indexes, the one characteristic all these strategies share is a passive portfolio manager. While most investors and advisors take comfort knowing that portfolio managers of traditional index strategies usually charge very low fees, the strategies in these new index ETFs charge considerably more. Although industry providers may indicate such ETFs don't charge as much as actively managed mutual fund strategies, which on average is true, they are often justified by calling these index ETFs "hybrid active." It would be incorrect to say these funds do almost as much work as managers of actively managed strategies. In fact, they do the exact same amount of work as any other index portfolio manager.

Presentation can display key differentiators when evaluating an investment strategy that are not just a matter of semantics. While some index strategies—whether called fundamental, strategic, alternative or smart beta—may vamp their amount of portfolio changes as being active, that nevertheless remains commonly known as turnover, and is not active. Industry discourse continues over which older, traditional indexes—a trigger for debate over which indexes and providers—should be recognized as benchmarks. New waves of custom index strategies may be marketed as active hybrids although they still remain passively managed as any index does.

The essential reminder remains to judge both active and passive strategies based on their investment merit and results. It is prudent to pay low costs for passive strategies regardless of the indexing terminology, and to the extent where an advisor feels that an active manager is worth their fee, expect higher costs for those managers who take discretion to produce better risk-adjusted returns for clients' portfolios.

Because of the SEC's approval of transparent, actively managed ETFs, advisors can now select from an increasing array of passively and actively managed ETFs for building and maintaining client portfolios. Over the next few years, more of these ETFs will reach their three-year anniversaries and provide advisors a better guide in assessing the skills of active portfolio managers.