Active ETFs hold promise but also pose pitfalls amid uncertainty

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Actively managed exchange-traded funds have a solid record of outperforming their indexes in the fixed-income sector, but they tend to falter for equities.GETTY IMAGES

Investors seeking a portfolio manager’s expertise to outperform the market or to better manage risk – without paying high fees for mutual funds – are increasingly turning to active exchange-traded funds.

Markets churned by U.S. tariff turmoil and trade wars have prompted a flood of new offerings in the actively managed ETF space, which includes equity, fixed income and specialty funds.

When times are tough, investors typically embrace active strategies that aim to surpass the performance of an index, since passive ETFs are designed to mirror, not beat, a specific benchmark. Active funds have a manager who monitors the holdings and tweaks them as necessary, whereas the approach with passive ETFs is more hands-off.

“When markets fall, active ETF investments rise,” Warner Wen, a senior product specialist at Capital Group Canada, notes in an April report.

Canadian ETFs are enjoying massive inflows, attracting a record $54.8-billion for the first half of 2025, with active funds accounting for 34 per cent of ETF assets under management, according to a recent National Bank Financial report.

“In certain areas, active management makes a big difference for risk-adjusted returns,” says Raj Lala, president and CEO of Evolve Funds Group Inc. He cites fixed income, emerging markets, some commodities, and small- to mid-capitalization stocks as sectors that might benefit, versus their large-cap Canadian and U.S. counterparts.

For instance, 59 per cent of U.S. active fixed-income managers beat their indexes in 2024, according to the twice-yearly S&P Indices Versus Active (SPIVA) scorecard that compares the performance of active equity and fixed-income funds.

By contrast, active managers’ performance in equities is generally quite grim for U.S. and Canadian funds, particularly over longer time frames. A mid-2023 SPIVA Canada report found that nearly 95 per cent of Canadian active equity funds underperformed the S&P/TSX Composite Index over the 10-year period ending June, 2023.

“In equities, passive often works well,” Mr. Lala says. “But in fixed income, passive ETFs give the most exposure to companies with the most debt, which isn’t always healthiest.”

He cautions investors to be picky in the active space and to base their selections on at least a few years of performance. A good information source is Morningstar Canada, which provides detailed fund-by-fund performance metrics and benchmark comparisons. Also, a fund company’s website must present historical performance versus an index.

The trimming of the weak and risky that’s involved with actively managed ETFs comes at a cost: compared with a weighted, average annual management-expense ratio of 0.18 per cent to 0.25 per cent for passive funds, active ETFs carry MERs of 0.64 per cent to 0.74 per cent, according to PWL Capital. ETFs, unlike mutual funds, trade on a stock exchange and as a category have lower fees while still offering diversification.

However, the reputation that passive ETFs have for providing easy diversification gets upended if a few major players make up a significant portion of an index. For example, a passive ETF that replicates the Standard & Poor’s 500 index is actually heavily concentrated in technology stocks since it is dominated by the “Magnificent 7” cohort of Apple Inc., Microsoft Corp., Alphabet Inc., Amazon.com Inc., Nvidia Corp., Meta Platforms Inc. and Tesla Inc. While they significantly outpaced the index in 2023 and 2024, and they have been slightly ahead this year, the seven accounted for 56 per cent of the S&P 500’s decline in 2022.

“Often in active management, avoiding stuff that doesn’t look great is just as beneficial to the portfolio,” says Alan Green, vice-president of ETFs with Toronto-based Dynamic Funds. Its active ETFs typically have a tiny fraction of the equities compared with benchmarks, and managers’ experience and intuition cannot be supplanted by artificial intelligence, he adds.

A pioneer of active-investing funds in Canada, Dynamic has seen heavy investor flows into fixed income. Dynamic Active Discount Bond ETF (DXDB), for example, has tripled from $200-million in assets to more than $600-million this year, Mr. Green says. The firm’s global fixed income fund (DXBG) has nearly doubled from the $448-million in assets from its Nov. 15 launch last year to $876-million by the end of June this year.

Among active equity ETFs, Canadian investors are reacting to U.S. trade policies by doubling flows to international funds versus North America-focused ETFs, Mr. Green says. Strong-performing active categories include gold mining and one-ticket balanced ETFs that are multi‑asset, all‑in‑one ETF portfolios that combine equities, fixed income and sometimes alternatives under conservative, balanced, or growth asset mixes.