What is an 'active' ETF?

Exchange-traded funds (ETFs) have long been a staple for investors – often seen as low-cost passive ‘trackers’ copying the performance of stock market indexes like the FTSE 100 or S&P 500.

But ‘active’ ETFs are gaining popularity. They keep the low costs and easy trading of the ETF structure, but let managers pick stocks in an effort to beat the market.

To understand the differences, it helps to start with how a traditional ETF works. Think of an ETF as a cross between a share and a fund – you buy it like a share, but instead of owning one company, you get a mix of investments that typically aim to mirror a stock market index like the FTSE 100. ETFs are also traded on stock exchanges, meaning their price changes throughout the day.

And because they don’t try to beat the market, ETFs usually have low costs, with fees built in – making them a popular way to build diversified portfolios and spread risk.

That’s ‘passive’ investing in a nutshell: broad, simple exposure that lets your money grow alongside the market. But that’s the world of passive ETFs – designed to track, not outpace. Active ETFs, on the other hand, take a bolder approach – aiming higher.

An active ETF is run by professional fund managers and is designed to outperform a benchmark or a sector. Unlike passive ETFs that follow an index, active ETFs have people behind them who make their own calls to try and provide greater returns.

Take an active ETF targeting the FTSE 100 – it usually includes most stocks from the index but may add others for a potential edge.

However, active ETFs typically cost more – through in-built management fees or performance charges. And it’s worth remembering here, too, that while there’s potential for stronger returns, they don’t always come out ahead against cheaper passive options.

Active ETFs are growing fast. In 2024, they passed $1 trillion in assets⁽¹⁾ – up 59% in a year – and now make up around 7.6% of the global ETF market.⁽²⁾

What’s behind the growth? Flexibility. Unlike traditional passive ETFs, which just follow an index, these active ETFs give managers the freedom to sidestep sectors under pressure, to react quickly, and act on new ideas.

They also suit investors who want a shot at higher returns, but still like the low costs and ease that come with ETFs. Like most ETFs, you don’t need a big sum to get started either – and because they trade like shares, you can buy or sell whenever markets are open.

Transparency is another draw. Some active ETFs publish daily updates, so you know exactly what’s inside – not always common with traditional actively managed funds.

That said, active ETFs don’t always outperform. Some years, simply tracking the market can deliver better results, especially after fees are factored in. So, while they offer potential, they carry the usual risks of active investing – and no guarantees of better returns.

Active ETFs are well established in the US, where the ETF market is huge. But things are changing this side of the Atlantic.

More active ETFs are being launched in the UK or Europe, making them easier to access. That includes funds focused on the UK or global markets – so it’s worth checking the fund’s objective, where its portfolio is invested, and what currency it’s in to see if it fits what you’re after. These details can affect your exposure to currency risk or how internationally diversified you are.

Details like these are usually listed in the ETF’s factsheet or its Key Investor Information Document (KIID).

Active ETFs aren’t just about stocks – some invest in bonds, while others concentrate on shares tied to specific themes like clean energy or income generation.

But how they do depends on the manager’s choices. Even similar funds can perform very differently, so it’s worth checking their track record (though that’s no guarantee for the future).

Also, if the fund manager updates either the strategy or its holdings, these changes can happen automatically within the ETF – so it makes sense to periodically check that the ETF still fits your goals.

And don’t forget fees. Active ETFs usually cost more than their passive counterparts, so they need to outperform both the market and those extra fees to be worthwhile.

Active ETFs may also do well in volatile markets by avoiding risks or spotting opportunities. But in steady markets, passive ETFs may match or even beat them – often at a lower cost.

But overall, as the active ETF universe grows, it’s adding new possibilities for investors to explore.

You might be weighing active ETFs against traditional actively managed funds – but it helps to know where they overlap and differ.

Both aim to beat the market and usually charge in-built management or performance fees. But they trade differently. Active ETFs can be bought and sold like shares throughout the investing day, while traditional funds are priced once daily and accessed through most investment platforms.

Your choice may come down to how hands-on you want to be, how you prefer to invest, the costs – including fees, which can vary between ETFs and funds and may impact your returns – and the objectives, track records and risk levels of each option.