Jan 3, 2023 What We Mean by an “Active” ETF

By Kaiju ETF Advisors


One criticism of the current crop of so-called “active ETFs” is that in many cases they’re not all that active.

As we noted in our white paper one of the criticisms of the current crop of so-called “active ETFs” is that in many cases they’re not all that active. While trading for trading’s sake can be costly and even counterproductive, trades conducted to advance a well-defined strategy can add alpha to a portfolio.

One strategy that benefits from active trading is “buy the dip” (BTD). BTD seeks to take advantage of a temporary dislocation in the price of a stock that otherwise would be trending higher, by buying at bottom of the selling trend and selling after it’s regained at least some of its true value.

The challenge for successfully executing a BTD strategy is twofold: first, to identify a true “dip” (a stock that will recover its value in a reasonable amount of time) versus a “dive” (one that will just go down and stay down or, worse, continue to decline). The distinction is not always obvious. Second, to efficiently move in and out of a position in a way that allows a fund to maximize value.

Multiple factors allow an investor to separate a dip from a dive. Through our research, we have identified what we believe are the 25 most significant when it comes to forecasting short-term price movement. But these factors are not static; they interact dynamically with a level of complexity that is beyond the ability of most human traders, or teams of traders, to understand and manage.

It’s for that reason that we employ artificial intelligence (AI) to analyze the factors and to support the decision-making process. AI allows a fund to make buy and sell decisions quickly and efficiently, thereby taking advantage of what it means to be “active.” Here again, trading is not done for its own sake. It’s done based on a deeply researched proprietary set of algorithms that are continually analyzing massive amounts of data and moving to take advantage of opportunities as they are identified.

In the case of our ETF, the BTD Capital Fund (Ticker: DIP), the holding period for any given security will typically range from one to seven days (though occasionally longer). Buying will generally occur when the algorithm’s analysis of technical indicators such as trading volume, price momentum, and liquidity indicate a stock has become oversold. Selling generally occurs when the algorithm determines the position is trading at fair value.

Growth of Active

The promise of active ETFs has led to the introduction of many new funds. According to ETF.com, there were about 270 active ETF launches in 2022 out of a total of 431 funds. Over the past three years the category represented the majority of ETF launches.

Active ETFs offer a number of advantages, depending on the strategy. Most significantly, they allow for daily trading of securities. These investment decisions can be made by a portfolio manager, or managers – or an algorithm. This stands in contrast to passive ETFs, which are designed to track an underlying index and generally rebalance (trade) only on a quarterly basis.

As is to be expected, some active ETFs have performed better than others. Some are simply a conversion of a mutual fund into the ETF format. (More than a dozen such conversions took place last year, a trend that seems poised to accelerate.) Of course, not every investment strategy lends itself to active management, nor to use of AI. Given its relatively short holding period for most securities, buy the dip is one that does.

The benefits can be seen through the lens of our investment process. DIP draws on 15 years of market data and dynamic machine learning and scientific statistical methods to manage the buying and selling of securities. It has been built from the ground up to take full advantage of the active ETF structure, including tax efficiency and portfolio diversification, as well as active management. Further, it is designed to be independent of market direction, identifying opportunities whether stocks are trending up or down.

With DIP, active means active. To find out more about the fund, go here.