The Case for Active ETFs

Experts say there could be an explosion of new active ETFs hitting the market in 2011.

By SHARE

Higher tax efficiency. By design, ETFs are more tax efficient than mutual funds. Essentially, ETF investors don't have to pay taxes on their capital gains until they sell. (With mutual funds, investors may incur taxes when a manager sells securities in the fund.) Investors in actively-managed funds can lose money over the long haul if their fund manager trades on a frequent basis. Granted, passive ETFs will always be more tax efficient than active ETFs because of their low turnover, but Burns says he expects active ETFs to be more efficient than their active mutual fund counterparts, saving investors money over the long term.

[See 5 Things You Should Do With Your Investments Now.]

Before you dive into actively managed funds, a word of caution: Many have only been in existence for a year or two. Morningstar recommends that investors wait until managers have proven their skills. "The one thing we know about active management is that the best way to improve your chances of picking a quality active manager is to wait for a three-year track record," Burns says.