Riding the Wave or Staying Flat | The Alternative Rhythm of Active ETFs

Recently, Xiao Lin encountered a typical issue: he holds both an active ETF and an actively managed traditional fund, noticing that their portfolios are similar, but their fee structures differ – so how should he decide?

In this educational session, we’ll walk you through the underlying logic of these two tools, from trading rhythms and cost structures to transparency of information!

What exactly is the difference between active ETFs and traditional active funds?

When investors discuss this issue, the focus can easily shift from structural understanding to 'which side has the advantage' or 'whether there is a substitution relationship.' However, if we slightly adjust the angle of this question, it becomes far more interesting: as investors, what are we truly gaining when we choose them, and what trade-offs do we need to accept? When we stop focusing on short-term performance and return to the tool itself, the answers often become much clearer.

Differences in trading methods shape distinct investment rhythms

The most intuitive difference between active ETFs and traditional active funds lies in the trading method. Active ETFs are traded on exchanges like stocks, allowing investors to enter or exit at any time during trading hours, with prices determined in real-time by market supply and demand. In contrast, traditional active funds stick to conventional practices where investors can only subscribe or redeem based on the net asset value (NAV) calculated after the market closes each day. On the surface, the real-time trading flexibility of ETFs appears superior, but this design also introduces a different pace. Real-time pricing means market information is constantly visible, making investors more susceptible to short-term volatility and requiring them to make more immediate decisions. Conversely, funds typically have one price per day; although they lack flexibility, this naturally slows down the investment process, preventing investors from being swayed by intraday fluctuations. This isn’t about which is more advanced, but rather that the tools themselves cater to different investment rhythms.

Bid-ask spreads and NAV deviations: Another side of costs

When discussing active ETFs and traditional active funds, many people immediately compare management fee levels, but this is only a small part of the story. Since ETFs trade on exchanges, both bid and ask prices exist simultaneously in the market, naturally creating a bid-ask spread. This spread represents one of the transaction costs investors bear every time they enter or exit. Moreover, because ETF prices are determined in real-time by market supply and demand, there may be temporary instances where the price exceeds or falls below the actual net asset value of its portfolio, resulting in premiums or discounts. It’s important to note that these deviations don’t necessarily indicate mispricing of the ETF but are normal phenomena stemming from the trading structure. Behind ETFs lies a creation and redemption mechanism, supported by market-making activities, designed to attract arbitrage forces to intervene when market prices deviate from portfolio value, pulling the price back towards NAV. In other words, the gap between an ETF's price and its NAV is more a 'trading-level' result rather than an issue with the portfolio itself.

In comparison, the pricing structure of traditional active funds is much simpler. Investors transact daily based solely on the NAV calculated after the market closes, directly reflecting the fund’s asset value for the day. There is no bid-ask spread, nor concepts of premium or discount. Investors face a clear, fixed price rather than fluctuating market quotes.

Therefore, the difference between the two is not necessarily about 'who has lower costs,' but rather the form in which costs manifest. ETF costs mostly occur at the moment of trading, tied to entry/exit timing and market liquidity, while fund costs are embedded more within the product’s management and operation. For investors, understanding this structural difference is often more crucial than merely comparing fee rates.

Differences in information transparency alter the investor ‘participation approach’

Aside from trading methods and price structures, another key difference between active ETFs and traditional active funds lies in how investors receive information and the frequency of updates. Many active ETFs disclose holdings daily or provide semi-transparent insights, allowing the market to continuously grasp the fund's general allocation. The intention behind this design is to enhance transparency, helping investors better understand what they own while aiding market pricing and liquidity operations. However, when information becomes real-time, investors are more likely to 'participate' actively in the investment process. When changes in holdings, style shifts, or market fluctuations are visible in real time, some investors unconsciously spend more time monitoring the product itself and even attempt to interpret the reasons behind short-term changes.

In contrast, the disclosure frequency of actively managed traditional funds is much slower. Investors typically rely on periodic reports to understand changes in holdings and strategies, with limited access to real-time information. This setup tends to shift their focus toward whether the strategy remains aligned with the original investment objective, rather than recent portfolio adjustments or short-term performance. This does not imply that more information is always better, nor does less information necessarily mean opacity; rather, these are two tools designed with different assumptions about the level of investor engagement. Some investors prefer to closely monitor developments in real time, while others are content to delegate the process to systematic oversight, reviewing outcomes periodically.

Comparing active ETFs with actively managed traditional funds is not a matter of declaring one winner over the other. Instead, they represent two distinct design philosophies: one emphasizes real-time responsiveness and flexibility, while the other provides structure and certainty. When used appropriately, both can deliver their intended value.

To learn more about ETFs: https://www.franklintempleton.com.hk/zh-hk/our-funds/capabilities/etf

The issuer of this document is Franklin Templeton Investments (Asia) Limited.

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