Active ETFs have become a popular investment option for retirement portfolios, combining aspects of both mutual funds and ETFs. While these funds aim to outperform market indexes through active strategies, their higher costs and mixed track records raise important questions that you may want to consider before adding them to your portfolio.
In this article, we’ll dive into the pros and cons of active ETFs and explore whether they might be a good fit for your retirement portfolio.
Understanding Active ETFs
Active ETFs are run by fund managers who try to beat the market. Unlike passive ETFs, they try to beat benchmarks through active security selection, sector allocation, and other hands-on strategies rather than mimicking the performance of an index. But unlike mutual funds, they have a more tax-efficient exchange-traded fund (ETF) structure.
Pros
- Alpha – Active ETFs have the potential to beat the market rather than match market performance, depending on the fund manager’s skill set.
- Strategies – Active ETFs have access to unique hedge fund-like strategies that are off-limits to most passive ETFs, such as options strategies.
- Adaptability – Active ETF managers can react to market events in real time rather than being forced to stay invested in an index.
Cons
- Cost – Active ETFs are more expensive than passive ETFs because they require dedicated research teams and incur more trading costs.
- Performance – Active ETFs tend to underperform their passive counterparts on the whole based on long-term data from Morningstar.
The Cons: Cost & Performance
Many long-term investors are already familiar with the cons of active ETFs because they mirror those of actively managed mutual funds. In fact, these cons are responsible for the rise of companies like Vanguard and the transition from mutual funds to ETFs. However, it’s worth spending some time understanding these cons in detail.
Impact of Fees
Active ETFs have higher expense ratios than their passive counterparts. While these differences may seem small, they have a major impact on your investment portfolio over time. For example, over 20 years, a 0.5% annual fee reduces a $100,000 portfolio’s returns by $10,000 compared to a 0.25% annual fee.
Source: SEC
Comparing Returns
Morningstar’s Active vs. Passive Barometer measures the performance of active ETFs compared to passive ETFs over time. While 51% of actively managed strategies survived and beat their average passive peers from July 2023 to July 2024, the overall long-term track record for active funds is subpar and consistently underperforms on the whole.
Source: Morningstar
The Pros: Risk, Strategy & Income
The case for active ETFs may seem bleak with their higher costs and underperformance. But, of course, this is a generalization. Some active ETFs have a great long-term track record and may be worth consideration. And others may offer unique strategies that help you meet your other non-total return goals, such as greater income or less risk.
Risk Management
Active ETFs offer a greater variety of strategies to help mitigate risk. For instance, the First Trust Long/Short Equity ETF (FTLS) plays both sides of the market to maintain a neutral market position. If the market moves higher, the fund may leave some money on the table, but if it moves lower, investors could see less loss or even some profits.
Risk Focused Active ETFs
They are sorted by their YTD total return, which ranges from -10% to 20%. They have AUM between $48M and $1.7B and expenses run between 0.59% and 3.68%. They are currently yielding between 1.7% and 7.9%.
| Name | Ticker | Type | Actively Managed? | AUM | YTD Total Ret (%) | Yield | Expense |
|---|---|---|---|---|---|---|---|
| First Trust Long/Short Equity ETF | FTLS | ETF | Yes | $1.67B | 20.2% | 1.7% | 1.46% |
| NYLI Hedge Multi-Strategy Tracker ETF | QAI | ETF | Yes | $637M | 6.8% | 3.8% | 1.13% |
| AdvisorShares Ranger Equity Bear ETF | HDGE | ETF | Yes | $48.9M | -8.7% | 7.9% | 3.68% |
| Cambria Tail Risk ETF | TAIL | ETF | Yes | $68.3M | -10.4% | 3.8% | 0.59% |
Unique Strategies
Active ETFs provide fund managers with more flexibility, which makes them ideal for small-cap, value, fixed-income, or international investing strategies. So, not surprisingly, on Morningstar’s Active vs. Passive Barometer, actively managed funds tend to perform the best.
Strategy Focused Active ETFs
They are sorted by their YTD total return, which ranges from 7% to 17%. They have AUM between $2.6B and $16.2B and expenses run between 0.25% and 0.44%. They are currently yielding between 1.5% and 3.9%.
| Name | Ticker | Type | Actively Managed? | AUM | YTD Total Ret (%) | Yield | Expense |
|---|---|---|---|---|---|---|---|
| JPMorgan Active Value ETF | JAVA | ETF | Yes | $2.6B | 16.6% | 1.5% | 0.44% |
| Avantis U.S. Small Cap Value ETF | AVUV | ETF | Yes | $16.2B | 9.2% | 1.8% | 0.25% |
| Dimensional International Value ETF | DFIV | ETF | YEs | $7.97B | 7.3% | 3.9% | 0.27% |
| Dimensional US Small Cap Value ETF | DFSV | ETF | Yes | $4.37B | 7% | 1.8% | 0.31% |
Income Generation
Active ETFs also enable managers to implement unique income strategies. For instance, the JPMorgan Equity Premium Income ETF (JEPI) is a popular active fund using covered call strategies to sell out-of-the-money calls on the S&P 500 while investing in a defensive stock portfolio, producing high income, low volatility, and tax efficiency.
Income Focused Active ETFs
They are sorted by their YTD total return, which ranges from 4.6% to 21.5%. They have AUM between $1.25B and $38B and expenses run between 0.2% and 0.56%. They are currently yielding between 2.1% and 8.2%.
| Name | Ticker | Type | Actively Managed? | AUM | YTD Total Ret (%) | Yield | Expense |
|---|---|---|---|---|---|---|---|
| Capital Group Dividend Value ETF | CGDV | ETF | Yes | $12.3B | 21.5% | 2.1% | 0.33% |
| Amplify CWP Enhanced Dividend Income ETF | DIVO | ETF | Yes | $3.89B | 17.2% | 4.8% | 0.56% |
| JPMorgan Equity Premium Income ETF | JEPI | ETF | Yes | $38B | 13.6% | 8.2% | 0.35% |
| Dimensional US Real Estate ETF | DFAR | ETF | Yes | $1.25B | 4.6% | 6.2% | 0.2% |
The Final Verdict
Active ETFs often get a bad rap due to their higher fees and worse total returns, but they may be suitable for some retirement portfolios, depending on your goals. For instance, if you’re risk averse and want to hedge against a market decline or want to boost income above and beyond dividends, you may want to consider active ETFs.
