There are a lot of terms the ETF industry uses every day, some of them unique to the ETF structure. Here’s a list of some of the most commonly used terms in ETF land, ordered alphabetically from letter A to B.
Actively Managed ETF: Most ETFs track an index, in what’s known as index-based or passive investing. An actively managed ETF is a fund that literally has a portfolio manager at the helm of the fund, making active allocation decisions rather than passively tracking a benchmark. Active managers have long been plagued with persistence issues—meaning that few outperform indexes, and the ones that do aren’t likely to repeat that outperformance consistently—hindering adoption of actively managed ETFs, which are often more expensive to own than their passive counterparts.
Alpha: Alpha is return that can’t be simply explained by market movement. In the ETF space, alpha is primarily the “extra juice” an active manager can extract beyond the market performance, as measured by an index. But it can also be outsized gains achieved through index-based ETFs that track some form of smart beta benchmark designed to deliver outperformance relative to a segment of the market.
Authorized Participant: He or she is the protagonist of the ETF creation/redemption process most investors will never know. Designated by an ETF issuer, the AP is someone with purchasing power who creates and redeems shares of an ETF, keeping the supply elastic to meet demand. When there’s new appetite for a given ETF, the AP will create shares of that ETF through the in-kind creation/redemption mechanism, keeping supply ample and helping the ETF trade in line with its net asset value (NAV). Ample supply means no need for steep premiums. When demand dries up and ETF share prices face a discount, the AP can redeem shares of the ETF from the market, reducing supply, allowing the ETF to trade back in line with its NAV. The AP plays a crucial role in ETF liquidity and trading.
Beta: Beta is the correlation between a stock and the broader market, or the performance of an ETF relative to the segment of the market it accesses. The higher the beta, the more sensitive a stock or an ETF is to market moves. (We list “beta” for most ETFs in our fund pages—etf.com/ticker—under the tab “Fit.”)
Bid/Ask Spread: ETFs trade like single stocks, so bid/ask spreads are a part of daily life for an ETF. The spread is simply the difference between the price someone is willing to pay for an ETF (the bid) and the price someone is willing to sell that ETF for (the ask). (If you like visuals, we have a short video about the mechanics of ETF trading here.) The most important takeaway here is that the wider the spread, the more expensive it is to trade that ETF. That’s why we list the “average spread” for all ETFs in our fund pages (etf.com/ticker) along with other crucial data points such as expense ratio, assets under management and average daily volume. This metric should be part of your ETF due diligence if costs are important to you.