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Active vs.
Passive ETF Investing
Source:
Investopedia.com |
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From an investment strategy standpoint, traditional exchange-traded
funds (ETFs) are designed to track indexes. ETFs are available in
hundreds of varieties, tracking nearly every index you can imagine;
they offer all of the benefits associated with index mutual funds,
including low turnover, low cost and broad diversification, plus their
expense ratios are significantly lower. While passive investing is a
popular strategy among ETF investors, it isn't the only strategy. Here
we explore ETF investment strategies to provide additional insight
into how investors are using these innovative instruments.
Passive Investing
ETFs were originally constructed to provide a single security that
tracks an index and trades intraday. Intraday trading enables
investors to buy and sell, in essence, all of the securities that make
up an entire market (such as the S&P 500 or the Nasdaq) with a single
trade. It thereby provides the flexibility to get into or out of a
position at any time throughout the day, unlike mutual funds, which
trade only once per day.
While the intraday trading capability is certainly a boon to active
traders, it is merely a convenience for investors who prefer to buy
and hold, which is still a valid and popular strategy - especially if
we keep in mind the often-cited statistic that 80% of actively managed
mutual funds fail to beat their benchmarks. In sum, ETFs provide a
convenient and low-cost way to implement indexing, or passive
management.
Active Trading
Despite indexing's track record, many investors aren't content to
settle for so-called average returns. Even though they know that a
minority of actively-managed funds beat the market, and they're
willing to try for a piece of that action. ETFs provide the perfect
tool. By allowing intraday trading, ETFs give these traders an
opportunity to track the direction of the market and trade
accordingly. Although still trading an index like a passive investor,
these active traders can take advantage of short-term movements. If
the S&P races upward when the markets open, active traders can lock in
the profits immediately.
So, all of the active trading strategies that can be used with
traditional stocks can also be used with ETFs. These strategies
include market timing, sector rotation, short selling and buying on
margin.
The tradability of ETFs is not the only thing that makes them good
tools for active trading. In the near future, another facet of active
management may soon be available in the form of professionally managed
ETFs.
Conclusion
Active and passive management are both legitimate and frequently used
investment strategies among ETF investors. While actively-managed ETFs
run by professional money managers are still scarce, you can bet that
innovative money management firms are working diligently to overcome
the challenges of making this product available worldwide.
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Active Model
Portfolios
& Trading Logs
4-Week Price
Performance
Year-to-DateTrend
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