Active ETFs have seen explosive growth — experts caution about their costs and risks
Investors have been flocking to actively managed ETFs with their assets under management growing five times more than those of passive funds in 2024, a Morningstar report showed. As these funds chase high performance, some analysts have raised concerns whether their returns justify the higher expenses and other risks. “Active funds add an extra layer of risk that doesn’t always translate to returns, especially considering their higher fees,” said Roxanna Islam, head of sector and industry research at financial data and insights platform TMX VettaFi. These funds, which attempt to beat the returns of benchmark indexes, generally have higher expense ratios than their passive peers which track a market index and require less active management. Active ETFs have an average management fee of 0.63%, compared with an average of 0.44% for passive funds, data from Morningstar showed. “They’re typically slightly more expensive than traditional passive ETF vehicles and investors will likely struggle to understand what they’re getting in return for those slightly higher fees,” said Don Calcagni, chief investment officer at Mercer Advisors, elaborating that active ETFs require more investment training and sophistication to execute. Market watchers whom CNBC spoke to said active ETFs can perform better in uncertain or volatile markets where skilled management adds value. Also, when compared to active mutual funds, with an average fee of 1.02%, active ETFs are relatively cheaper. The average annual return over a five-year period for active ETFs in the U.S. stands at 5.57%, while for passive ETFs it is 4.27%, Morningstar data showed. Their outperformance seems attractive enough even when accounting for a higher fee — but there are other costs too. ‘Unseen’ costs While cheaper than mutual funds, active ETFs often have wider bid and ask spreads, especially for newer funds, pointed out Gareth Nicholson, chief investment officer at Nomura’s international wealth management team. The bid-ask spread represents the gap between the highest price a buyer is ready to pay for an asset and the least a seller wants to accept. A wide bid-ask spread generally signals lower liquidity in the market, and may result in higher transaction costs for traders as compensation for the illiquidity. “These unseen trading costs can eat into returns,” he told CNBC. Active ETFs, which trade in real-time, are also more susceptible to market swings unlike mutual funds which price once a day, Nicholson added. Similar to mutual funds, only a small percentage of active ETFs consistently outperform their benchmarks, the Nomura chief investment officer said. The average alpha, or outperformance compared with peers, delivered by active ETFs in the U.S. — which houses over 80% of these funds globally — in 2024 is in the negative, at -1.34%, data provided by Morningstar showed. A particularly risky class of active ETFs are single-stock funds. When Nvidia shares saw a sharp decline last month, single-stock leveraged ETFs betting on the company’s growth saw record single-day losses of over 33% , further highlighting key risks of active strategies. “Leverage amplifies volatility — when markets move against you, losses are magnified,” Nicholson said. Leveraged ETFs fall under the active management category, where the funds are designed to deliver twice or thrice the performance of a specific stock on a single-day basis. The flip side is: losses are also amplified.
