News Room
Active ETFs blend regular counterparts and mutual funds
By Eileen Ambrose
March 28, 2010

With more than 900 exchange-traded funds, you can find one that fits every investment sector, strategy or mood you're in. Now get ready for even more variety with actively managed ETFs.

This new product combines the tax and cost advantages of a regular ETF with the expertise of a professional money manager that you get with most mutual funds.

Baltimore's Legg Mason and T. Rowe Price Associates, along with other fund companies such as Vanguard Group and John Hancock Funds, are seeking approval from the Securities and Exchange Commission to offer actively managed ETFs.

"They are an up-and-coming thing," says Brenda Wenning, a money manager at Wenning Investments in Massachusetts. "You will see mutual fund companies moving in that direction."
But the real question for investors will be whether paying a little extra for a professional to manage an ETF is worth the cost.

"That's really the million-dollar question with active management," says John Gabriel, an ETF analyst with Morningstar, which tracks funds
.
Regular ETFs have been around for 17 years, and almost all of them passively track a benchmark, such as the S&P 500 index. A big advantage is that ETFs can trade like a stock throughout the day - something you can't do with a mutual fund.

Actively managed ETFs were introduced two years ago, and there are 19 of them with a total of $344 million in assets, according to Morningstar. That's a small slice of the $800 billion in all ETFs.

With an active ETF, a money manager - not some index - decides what securities to hold with the goal of outperforming the market. That's the same objective of an actively managed mutual fund, but again an ETF has benefits that the old-fashioned mutual fund doesn't.

Because an ETF trades like a stock, you can get the price of the shares at the time you buy or sell, giving you more control. When you execute a trade with a mutual fund, you get whatever the price is at the end of the day.
ETFs can trade securities in a way that avoids or reduces capital gains, so investors might not be hit with a tax bill each year. (You could owe taxes when you sell your stake in the ETF, though.)

Mutual funds trigger capital gains when they sell securities for a profit, and they are required each year to pass those gains onto investors. Because of this, you can owe capital gains tax even though your mutual fund plunged that year. Ouch!