ETFs have become increasingly popular in the wake of the financial crisis because of the advantage they offer in terms of liquidity, transparency, and cost, but in the past they have only provided a cheap beta investment. Actively managed ETFs change that by giving a management team the right to trade the underlying stocks. You’re no longer guaranteed returns in-line with the underlying index, but you get to implement more complex strategies while keeping all the advantages that have made passive ETFs popular.

ETFs represent a better mousetrap

“If current trends persist and active ETFs gain approval and marketplace traction, industry observers suggest that there is no reason why growth cannot reach $5 trillion AUM in the next three to five years,” according to recent PricewaterhouseCoopers report (h/t Brendan Conway). “For many, ETFs represent a better mousetrap when compared to traditional mutual funds. This is particularly true for advisors who have been at the forefront of a movement that places less emphasis on security selection while focusing more heavily on asset allocation.”

Active ETFs face regulatory hurdles, unlike passive ETFs, there is no generic filing process and Securities and Exchange Commission (SEC) approval can take a year or more for each product, but they currently account for about 1% of total ETF assets under management. If the process for creating ETFs were to be streamlined so that new strategies could be used to attract a more diverse set of investors, there’s no reason ETFs couldn’t explode like the PWC report suggests.

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Passive ETFs are past the stage of easy growth

Passive ETFs are past the stage of quick, easy growth, at least in the U.S. There’s still room for more funds in Europe and Asia, but those markets will also mature over the next couple of years, and it’s not as easy to keep up as it used to be. “Although have been launching in growing numbers, they’re also being closed at an unprecedented pace,” the PWC report says. “An increasingly crowded market caused a record number of ETFs to report net redemptions in 2012.” But again this is almost entirely made up of passive ETFs, and active ETFs could be an incredibly disruptive financial product.

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