In the world of wealth management , active ETFs are playing an increasingly important role for investors with high demands in terms of flexibility, returns and transparency. They combine the advantages of traditional passive ETFs - such as daily tradability and cost efficiency - with the opportunities of active management, in which fund managers specifically strive for above-average returns. In combination with a long-term overall portfolio strategy, active ETFs thus offer a valuable option for reacting flexibly to market changes and exploiting market opportunities through well-founded decisions. With this in mind, our investment team at FINVIA has decided to integrate active ETFs into our wealth management in order to provide our clients with even greater diversification within their investment strategies. In this article, we take a look at how they work, their advantages and disadvantages and the role of active ETFs in a modern, diversified asset strategy.

What are active ETFs

Active ETFs combine the structure of an exchange-traded fund with the strategy of an actively managed investment fund. This means that they are traded on the stock exchange like conventional ETFs, but can react flexibly to market changes through active management. For example, they can switch to lower-risk investments or defensive sectors when market conditions require it. While passive ETFs aim to replicate a specific index such as the S&P 500 or the DAX as closely as possible, active ETFs follow a predetermined investment strategy based on the current market environment or the assessment of an investment team.

Growing market

The market for active ETFs is experiencing impressive growth. At the end of 2023, wealth assets under management in active ETFs worldwide reached around USD 740 billion, an increase of 52.4% compared to the previous year. On the German Xetra exchange alone, the wealth of active ETFs under management rose by 48.5% to EUR 22.3 billion.

Advantages of active ETFs

Flexibility: Active ETFs can react quickly to market changes and adjust portfolios accordingly. This flexibility enables a broader diversification of risk and reduces dependence on traditional market benchmarks.

Potential for excess returns: Fund managers of active ETFs often work with specialized research teams to target excess returns. Active management therefore offers the opportunity to outperform the market by picking up opportunities that are not captured by passive ETFs, for example by selecting innovative companies or regions with a strong growth momentum.

Transparency: Compared to traditional actively managed funds, active ETFs offer greater transparency regarding their portfolio composition. Many active ETFs publish their current holdings on a daily basis, giving investors insight into the investment strategy.

Liquidity: Just like passive ETFs, active ETFs can be traded during regular exchange trading hours. This provides investors with high liquidity, which is invaluable, especially in larger portfolios, as adjustments can be made at any time without having to wait for traditional funds to settle.

Cost efficiency: Although they are more expensive than passive ETFs, active ETFs are often cheaper than traditional actively managed funds. The fees are generally between the two models.

Types of active ETFs

There are different types of active ETFs that focus on different asset classes and strategies:

• Equity ETFs: Focus on selecting stocks in specific sectors or regions to benefit from specific growth opportunities.
• Bond ETFs: Actively manage bond portfolios to achieve either higher returns or lower risk through targeted bond selection.
• Multi-asset ETFs: Combine different asset classes and actively adjust the allocation to benefit from different market conditions.
• ESG ETFs: These ETFs focus on sustainable investments that take environmental, social and governance (ESG) criteria into account. They offer investors the opportunity to achieve returns while also meeting ethical and ecological requirements.

Who are active ETFs suitable for?

Active ETFs not only offer specific advantages in diversified asset portfolios, but are also of interest to different types of investors:

• Investors seeking outperformance: Investors who expect higher returns than the market performance that can be achieved with passive index funds will find active ETFs an efficient instrument.
• Investors who value active risk management: Active ETFs offer fund managers the opportunity to react dynamically to market fluctuations and minimize risk through targeted investment decisions.
• Investors who benefit from the advantages of ETFs without having to forego active management: The combination of an active investment strategy and the structural advantages of ETFs - such as high liquidity - makes these products particularly attractive.

Challenges and risks

Despite their advantages, active ETFs also come with some challenges:

1. Higher costs: Management fees are generally higher than for passive ETFs, as active management requires additional effort.
2. Management risk: The performance of active ETFs depends heavily on the decisions of the fund manager. Poorer management can lead to poorer performance. Historically, it is difficult to consistently beat the market over a longer period of time.
3. Tracking error: Since active ETFs deliberately deviate from the index in order to achieve potentially higher returns, the deviation (tracking error) can be greater than with passive ETFs.
4. Complexity: The strategies behind active ETFs can be more difficult for investors to understand. They often require a deeper understanding of the markets and investment strategies.

Outlook and trends

The future looks promising for active ETFs. Especially in areas such as ESG investments and niche markets, active ETFs are likely to gain further importance. The growing focus on sustainable investments and new regulations, such as the EU taxonomy, are driving demand for ESG ETFs as investors increasingly emphasize environmentally friendly and socially responsible investment strategies.

Another interesting aspect of active ETFs is rule-based investment strategies. Unlike passive ETFs, which typically follow a predetermined index and fully disclose the underlying rules, active ETFs can select specific information in rule-based strategies. This gives providers the opportunity to develop innovative and proprietary strategies that give them a competitive advantage. Such approaches could become more relevant, particularly when selecting companies according to specific factors - such as growth opportunities, quality characteristics or risk profiles - and further differentiate the market for active ETFs.

Conclusion

Active ETFs represent an interesting development on the ETF market. They offer flexibility, liquidity and the possibility of outperformance - factors that are particularly important in large portfolios. Especially in times when flexible and sustainable investment strategies are in greater demand, active ETFs can be a useful addition to a diversified asset strategy. They complement long-term strategies, but also offer the opportunity to react flexibly to short-term market changes.

However, it is important for investors to understand the specific characteristics and risks of active ETFs and to carefully consider whether they suit their own investment objectives and risk tolerance. While passive ETFs are often better suited to long-term investors with a focus on low costs, active ETFs can be particularly advantageous in volatile or specific markets. Ultimately, investors should decide which type of ETF is best for them based on their individual goals, risk tolerance and understanding of the market.

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