Three Best Practices for Active ETFs

As the active ETF structure seemingly takes preference as a more contemporary and modern vehicle for investors, there may be some advisors that remain on the fence due to some common misconceptions regarding these products. In a conversation led by Bryan Moore, ETF Capital Markets, Harbor detailed three best practices in purchasing and trading active ETFs for your clients.

1. Wrapping Your Head around the Active ETF Wrapper

With the passing of rule 6c-11 in 2019, the SEC effectively leveled the playing field by removing the need for exemptive relief and making it easier for new entrants to launch ETFs. In the years since, we have seen a precipitous uptake in assets under management in the ETF space by a wide variety of firms that now feel comfortable taking their best strategies to the marketplace, including some boutique managers who had otherwise felt precluded from bringing their ideas to the retail masses.

According to Morningstar, there are now 1,160 active ETFs listed on the exchanges with roughly 450 billion in assets under management as of September 2023. Notably, 75% of the ETFs launched this year are active, speaking to the trend toward this subset of the market.

2. Improving Your Understanding around Liquidity

We think it is important to note that active ETF liquidity is not just what you see onscreen in the average daily trading volume or the culmination of stock exchanges putting out bids and offers. Instead, we point to implied liquidity as a truer representation of a product’s fluidness. Implied liquidity measures liquidity in terms of the least liquid underlying position held within an ETF wrapper and how much can be traded in that name.

In restricting yourself to ETFs that are deemed as onscreen liquid, we estimate that you are limiting yourself to only about 10% of the U.S.-listed ETF universe. In contrast, a market maker is able to look through the active ETF wrapper to analyze the actual holdings within to establish a liquidity profile for that product. As an advisor, in leveraging a custodian or dedicated trading desk you too can gain an understanding of the implied liquidity of an active ETF and more confidently make recommendations to your client.

3. Trading Ins and Outs

We recommend utilizing a custodian or dedicated trading desk to ensure best execution on your active ETF trades given their connectedness to major market makers. Importantly, these resources are equipped to save you money on your trade via execution costs and avoidance of slippage. In addition, working with trading specialists can help you avoid trading around news or releases of reports that you may not be aware of that are causing volatility in the market.

If you do decide to trade on your own, we find that it may be best to avoid trading in the first 30 minutes of the day and the last 30 minutes of the day when markets tend to be a bit wider as market makers look to open and close stocks.

To learn more about ETFs and explore Harbor’s lineup of active offerings, please visit our website.

Important Information

The views expressed herein may not be reflective of current opinions, are subject to change without prior notice. This material is for informational and illustrative purposes only. This material does not constitute investment advice and should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy.

Past performance is no guarantee of future results.

Unlike mutual funds, ETFs may trade at a premium or discount to their net asset value. Shares are bought and sold at market price not net asset value (NAV). Market price returns are based upon the closing composite market price and do not represent the returns you would receive if you traded shares at other times. All investments are subject to market risk, including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. Bonds may decline in response to rising interest rates, a credit rating downgrade or failure of the issue to make timely payments of interest or principal. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets.

Fixed income securities fluctuate in price in response to various factors, including changes in interest rates, changes in market conditions and issuer-specific events, and the value of an investment may go down. This means the potential to lose money.

As interest rates rise, the values of fixed income securities are likely to decrease and reduce the value of a portfolio. Securities with longer durations tend to be more sensitive to changes in interest rates and are usually more volatile than securities with shorter durations. Interest rates in the U.S. are near historic lows, which may increase exposure to risks associated with rising rates. Additionally, rising interest rates may lead to increased redemptions, increased volatility and decreased liquidity in the fixed income markets.

Investing entails risks and there can be no assurance that any investment will achieve profits or avoid incurring losses.

ETFs are subject to capital gains tax and taxation of dividend income. However, ETFs are structured in such a manner that taxes are generally minimized for the holder of the ETF. An ETF manager accommodates investment inflows and outflows by creating or redeeming “creation units,” which are baskets of assets. As a result, the investor usually is not exposed to capital gains on any individual security in the underlying portfolio. However, capital gains tax may be incurred by the investor after the ETF is sold.

Slippage refers to the difference between the expected price of a trade and the price at which the trade is executed.

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