ETF Investing: Active vs. Passive Styles


You can find hundreds of different types of ETFs that track every index. So, ETFs offer nearly all the advantages of index mutual funds, such as low turnover, cheap costs, broad diversification, and lower expense ratios.

Although most investors think that ETF investing is synonymous to passive investing, it is not necessarily always the case. 

ETFs can also be traded actively. In this article, we explain the difference between the active and passive style of investing in ETFs, as well as the advantages and disadvantages of both. Read on! 

Passive ETF Investing

At first, ETFs served as a single security that tracks an index while also trading intraday, which lets the traders buy and sell all of the securities making up a whole market using only one asset—the ETF. 

As a result, ETFs provide the flexibility to enter and exit a position quickly at any time through the day. This is a striking contrast to mutual funds, which trade only once a day.

Although intraday trading is definitely a huge advantage of the more active traders, it is simply another convenience for investors who subscribe to the buy-and-hold strategy.

The buy-and-hold technique is a popular strategy. And it is more appealing when to think about the fact that most actively managed funds do not beat their benchmarks or other passive counterparts, particularly on the longer-term. 

Overall, ETF investing offers an easy and cheap way to pursue indexing or passive management. 

Active ETFs Trading

Despite indexing’s record, a huge number of investors do not settle for only average returns. Even if they know that only the small chunk of actively managed funds actually manages to beat the market, they still want to pursue active ETF investing. 

Since it allows intraday trading, ETFs provide the traders some chance to track the direction of the market and trade based on that.

Even though they are still trading an index, which is very similar to a passive investor, such active traders can take advantage of the short-term movements. 

In other words, all the other trading strategies used in trading stocks can also be applied to ETF active trading. 

These strategies include market timing, short selling, sector rotation, and trading on margin. 

Actively Managed Funds 

Even though ETFs are really designed to copy an index, they can still be tweaked to follow an investment manager’s top picks. They can also even mirror any existing mutual funds or pursue a specific investment objective. 

Apart from the way they are traded, these ETFs can offer investors and traders the investments that aims to deliver higher-than-average returns. 

Actively managed ETFs have the capability to benefit mutual fund investors and fund managers. If an ETF is created to mirror a particular mutual fund, active traders will use the ETF instead of the mutual fund because of the intraday trading capabilities of the fund. 

This will reduce the cash flow in and out of the mutual fund. This also makes the portfolio easier to manage and more cost-effective, boosting the mutual fund’s value for its investors. 

At Profit Star we strive to bring the best out of our students, guiding them through the complex world of financial markets.