How ‘Active ETFs’ Are Shaking Up Passive Investing

Exchange-traded funds are simple, cheap and hugely popular. Their goal is to invest in or replicate the performance of a basket of assets or index. Rather than pay a money manager hefty fees to actively pick and choose what the fund holds, ETFs traditionally have been “passive” investments, automatically buying and selling based on the benchmark being tracked. Now a hybrid approach known as active ETFs that seek to keep the advantages of the format while outperforming benchmarks is gaining adherents, thanks in no small part to the success of Cathie Wood and Ark Investment Management. It remains to be seen if her peers can replicate her stunning returns or will simply repeat the fee-laden underperformance that has long dogged active management. Questions have been raised in particular about a breed of active ETF that lets managers keep their strategies under wraps.

Like all ETFs, they offer investors part ownership of a pool of assets via shares that trade publicly on an exchange all day. Each also has a benchmark index, reflecting an investment strategy focused on a particular market sector or theme, like large cap companies or disruptive technologies. The difference in an active ETF is that a manager or team runs the fund -- they are actively trying to beat their benchmark, and they have discretion over what to buy and sell in order to do so. This means they can deviate from the benchmark as they see fit, for example by choosing to sell stocks that are under-performing and substitute new ones.