WHY ETFS ARE PASSIVELY MANAGED?

Most exchange-traded funds are passively managed. You may be wondering why. Let us count the reasons.

ETFs are Indexed Funds

Majority of ETFs are indexed funds which are passively managed. The funds invest in the same stocks as a particular index. Therefore, the fund manager cannot sell the shares unless the index removes itself from its list. All trading activity executed by an index fund is ignited by a change in the index it monitors.

Actively Managed Funds Fail to Deliver

An actively managed fund facilitates trades outside of what the index is performing. However, such funds often fail to render what they promise, not to mention the higher expense ratios brought by increased work required of the manager. Supposedly a fund surpasses the market, but expenses devour a considerable portion of its returns, leaving little or nothing to its investors.

Passively managed funds are designed to mirror the index’s return, regardless of its overall performance. While active funds present greater opportunities, passively managed ETFs offer greater expense reductions. And regardless of the returns, expenses won’t likely endanger shareholder profit for a given year.

Cost-Friendly and Tax-Efficient

Normally, passively managed funds have lower expense ratios than actively managed ones. These ETFs need not to rebalance their portfolio frequently due to its market-based trading and capacity to create and redeem shares in-kind. It makes them less likely to make capital gains distributions, which escalates the taxable income for their investors. ETFs are generally less susceptible to frequent distributions unlike mutual funds, meaning lesser tax obligations. The reduced number of distributions further reduces the expense ratio of passively managed funds.

Low Asset Turnover

Passive management requires minimal trading activity; hence, low asset turnover. A fund only needs man hours and paperwork to purchase or sell a stock. This increases the costs that are then disbursed to shareholders. Asset turnover are also reduced as ETFs are traded on the secondary market, making it less possible to sell assets to cover a shareholder redemption.

Consider this when choosing an ETF: look at the index, not the manager.