• Active ETFs are pooled investments in which a fund manager makes decisions about the portfolio's composition.
  • Demand for active ETFs has been rising because investors believe these funds may offer certain potential advantages, depending on market conditions, over their passive index counterparts.
  • Active ETFs are often easier to trade, less expensive, and more tax-efficient than active mutual funds with similar investment strategies.
  • Investors considering active ETFs may want to review their objectives, performance, and distribution history before adding them to their portfolios.

ETFs, or exchange-traded funds, have become a very popular way to invest across a wide variety of assets using a single security. While these funds have classically been passive by nature, demand for actively managed ETFs (i.e., active ETFs) has increased significantly, with the number of offerings now overtaking their passive counterparts as of 2025.[1] 

Here's what you need to know about active ETFs and why they're becoming popular among investors.

What Are Active ETFs?

An active ETF is an investment product whose assets and strategy are handled by professional fund managers. Their goal is typically to outperform a broad market benchmark by holding a specific blend of securities or by leveraging other advanced investment strategies.

Understanding the Basics of Exchange-Traded Funds

An ETF is a pool group of investments that combines some of the best characteristics of mutual funds and stocks.

  • Like mutual funds, ETFs offer broad diversification by combining several asset types into a single, investable portfolio.
  • Like stocks, ETFs may be publicly traded during normal market hours; sometimes at a discount to their net asset value (NAV).

How Active ETFs Differ from Passive ETFs

Historically, many ETFs were created to passively mirror major market benchmarks. For instance, an S&P (Standard & Poor’s) 500 index ETF would simply invest in the S&P 500 - a group of the 500 largest publicly traded U.S. companies. By holding the same representative basket of these 500 stocks, the ETF’s performance should align with that of the index without the need for management oversight or day-to-day decision making.

While passive ETFs are often praised for their simplicity and low cost, some investors believe active management may lead to performance that differs from that of the market. Hence, the demand for active ETFs has grown over the years. In fact, ever since a Securities and Exchange Commission (SEC) rule change in 2019, the number of actively managed funds has nearly quadrupled.[1]

It should be noted that active ETFs might sometimes use different investment strategies than passive ones. Therefore, it may not always be accurate to compare an active ETF against a passive index.  

How Do Active ETFs Work?

Common to all ETFs, the fund will be created with a stated investment objective. For example, it may claim that it seeks to produce consistent income for retirees or achieve lower volatility than the S&P 500. This information is generally found in its prospectus.

With this objective in mind, the fund manager and their team will then decide which assets the fund should hold to achieve this goal. For example, the ETF may choose to only include carefully screened stocks that meet certain performance criteria. Sometimes these funds may also choose to include advanced investment techniques such as using options or futures contracts.

Each day as the market fluctuates, management reacts dynamically by making decisions about what to do next. This may be to trade some assets, alter the dividend yield, or fine-tune their overall strategy. Considerations for how the fund might be made more tax-efficient may also be taken into consideration.

Benefits of Active ETFs for Investors

Active ETFs have several key features that may be advantageous for certain investors. The following are a few highlights.

Potential for Outperformance

In some years, active ETFs may produce higher gains than their passive index counterparts. Additionally, some active ETFs may produce greater distributions or maintain portfolio value stability. 

Accessibility

Compared to mutual funds with similar assets or investment strategies, active ETFs are generally easier to purchase and provide better liquidity. This is because some mutual funds are exclusive to a single financial institution and require minimum investments ranging from $1,000 to $100,000. By contrast, active ETFs may be bought and sold using any brokerage for virtually any amount (usually greater than $1).

Cost

Relative to most mutual funds, active ETFs often carry lower annual expense ratios. An expense ratio is an administrative fee the fund charges to the investor to cover its operating expenses. 

According to publicly available industry averages, an active ETF carries a 0.51% expense ratio versus the 1.01% fee charged by a typical mutual fund.[2] However, when compared to a passive ETF, the passive ETF will generally charge much less.

Tax Efficiency

By structure, ETFs are generally more tax-efficient than mutual funds because their in-kind creation and redemption process often results in fewer capital gains distributions. Other tax mitigation techniques may also be used, such as classifying distributions as return of capital (ROC) rather than ordinary dividends.

Transparency

ETFs (both active and passive) are required to disclose their full holdings daily. This provides investors with frequent transparency regarding holdings versus a mutual fund, which is only required to make the same types of disclosures quarterly.

Is an Active ETF Right for You?

Active ETFs may be a good fit for some investors. However, this will largely depend on your individual financial goals and objectives.

To determine if one is right for you, consider the following points:

  • How has the fund compared to similar passive ETFs? Has it produced higher gains, better stability, or higher distributions?
  • Does this ETF hold securities or other assets you feel comfortable owning?
  • How long has the fund manager been active with this ETF? Have they demonstrated that they’re able to deliver upon its objectives?
  • Does this ETF use an investment strategy that you understand or believe might achieve its goals?
  • Which tax efficiencies will the fund manager utilize to help ensure that your tax bill is affected as little as possible?

How Active ETFs Fit into a Diversified Portfolio

As with all investments, active ETFs should be selected based on their perceived ability to fulfill a need within your overall financial objectives.

For instance, you may wish to invest in an actively managed ETF that has:

  • Demonstrated a history of outperforming its benchmark if you’d like to maximize overall annual returns. (Note: Past performance is not a guarantee of future results.)
  • Achieved modest gains with minimal portfolio volatility if you’re concerned about loss of principal.
  • Delivered above-average distributions if you rely on this income for retirement or other financial needs.

Often, a mixture of both active and passive ETFs may help to round out your portfolio and help you reap the advantages of both types of securities.

Final Thoughts

Active ETFs leverage the expertise and decision-making of fund managers to gain an edge over their passive counterparts through higher returns or better performance. However, success isn’t always guaranteed.

For the highest chances of success, you may want to select funds that have a proven track record and inspire confidence that they will be able to deliver upon their objectives. Aim for a diverse portfolio that includes active ETFs as well as other types of securities that align with your financial goals.