As exchange-traded funds (ETFs) continue to transform how investors access markets, active ETFs are fast emerging as a critical component of modern portfolio strategies. While their ability to deliver potential outperformance, or alpha, is well recognized, a less discussed—but equally crucial—dimension is the total cost of ownership (TCO). Investors increasingly realise that headline expense ratios reveal only part of the cost equation. To make informed decisions, they must look deeper into structural and operational factors affecting real-world returns, especially during periods of heightened market volatility.

This article leverages insights from Brieuc Louchard, Head of ETF Capital Markets at AXA Investment Managers, to dissect the hidden and explicit costs associated with active ETFs. We explore why understanding TCO is essential for both institutional and retail investors, how the landscape is evolving, and what best practices are emerging for cost-effective ETF deployment.

Beyond Headline Fees: What Drives the Total Cost of Ownership?

Traditionally, ETF investors have focused on the annual expense ratio—the explicit management fee—as the primary indicator of costs. However, TCO encompasses a broader spectrum, which includes the following key components:

• Expense Ratio: The annual fee charged by fund managers, expressed as a percentage of assets.
• Bid-Ask Spread: The difference between the highest price a buyer is willing to pay and the lowest price a seller will accept. Tighter spreads equate to lower transaction costs.
• Trading Fees: Brokerage commissions and other trading expenses, which can vary depending on market venue, trade size, and broker relationships.
• Premiums and Discounts: ETFs can trade above (premium) or below (discount) their net asset value (NAV) due to supply/demand imbalances, especially in volatile markets or in less liquid ETFs.
• Tracking Error (for index ETFs): The degree to which an ETF’s returns deviate from its benchmark index. High tracking error can erode expected returns through more frequent rebalancing and higher portfolio turnover.
• Market Impact Costs: Large trades, particularly in less liquid ETFs, can move prices unfavorably, adding implicit costs to investors.

Louchard points out that relying solely on displayed expense ratios may lead investors to underestimate the true economic costs of holding an ETF. For example, European ETFs, governed primarily under the UCITS (Undertakings for Collective Investment in Transferable Securities) directive, are listed across multiple exchanges and multilateral trading venues. As a result, the actual liquidity may be fragmented and not fully visible on traditional order books, a nuance especially relevant for cross-listed products.

The Role of Liquidity and Platform Structure

Modern ETF trading is dominated by over-the-counter (OTC) transactions and request-for-quote (RFQ) platforms. Institutional investors who use RFQ platforms often benefit from tighter Bid-Ask spreads and enhanced price discovery. The liquidity of the underlying securities—such as equities, bonds, or alternatives—remains a primary driver of ETF trading costs. ETFs tracking highly liquid benchmarks like the S&P 500 or Euro Stoxx 50 typically see narrower spreads and deeper markets. Conversely, those invested in niche sectors or emerging markets may command wider spreads, amplifying TCO.

AXA Investment Managers’ dedicated ETF capital markets team works to establish robust relationships with market makers, brokers, and exchanges, aiming to minimize costs and optimize the investor trading experience. Their focus: ensuring effective communication and reducing the information asymmetry that can inflate spreads in active ETFs, where portfolio adjustments are less predictable compared to passive funds.

Active ETFs: Uncovering Hidden Costs

Active ETFs, designed for portfolio managers to dynamically adjust holdings in response to market opportunities, often have broader bid-ask spreads than traditional index-based funds. This is due to several factors:

• Lower transparency in portfolio composition compared to passive ETFs means market makers take on more risk and thus require compensation through wider spreads.
• Absence of related derivatives (like futures or options on indices), which limits market makers’ ability to hedge and manage risk efficiently.
• Higher turnover or more frequent trading inside the fund, which can elevate trading costs for the underlying securities and contribute to increased TCO.

Despite these factors, AXA and other ETF managers emphasize that active ETFs are becoming more cost-competitive, particularly as volumes and investor flows grow. Many active ETFs now offer expense ratios close to those of passively managed ETFs, and ongoing market innovation is steadily narrowing bid-ask spreads as liquidity improves. In the US, for example, active ETF assets surpassed $600 billion in early 2025 (source: Barron’s, 2025), illustrating growing investor acceptance and platform maturation.

Potential for Outperformance and Adaptive Strategies

One of the key advantages of active ETFs is the ability to adapt asset allocations swiftly in response to fast-changing market conditions. In volatile or sideways markets—in which major indices may stagnate or experience whipsaw movements—active management can help mitigate losses, seek out undervalued segments, or pursue relative value trades. Evidence from 2023–2024 highlighted periods where active managers in both equity and fixed income outperformed their passive counterparts, particularly during bouts of inflation and global macro shocks (source: Morningstar, 2024).

For investors, this flexibility is attractive, but only if extra management costs do not outweigh potential gains. The ability to execute tactical shifts at lower trading costs—thanks to ETF market structure innovations—has made active ETFs particularly compelling for institutional allocators and wealth managers seeking to hedge portfolios or reallocate in real time.

Practical Takeaways for Investors Considering Active ETFs

• Analyze TCO Holistically: Go beyond headline fees to consider liquidity, trading costs, premiums/discounts, and market structure. Compare TCO across providers before investing.
• Prioritize Fund Liquidity: Higher AUM funds with deeper secondary market liquidity offer better execution and lower trading costs.
• Choose Reputable Managers: Seek ETF providers with strong capital markets teams and established relationships to minimize operational frictions.
• Monitor Market Volatility: During turbulent periods, spreads can widen and premiums/discounts can increase. Stay informed about macroeconomic conditions and trading environment.
• Assess Active Advantage: Ensure that the potential for alpha generation justifies the higher structural costs, and evaluate ongoing fund disclosures for transparency and risk alignment.

With regulatory advancements, particularly under the European Union’s MiFID II and UCITS rules, investor protections and transparency requirements continue to improve. As the market matures, active ETFs are increasingly positioned to compete on both cost efficiency and performance, making them viable tools for sophisticated portfolio construction.

Risks, Disclaimers, and Final Thoughts

Regardless of strategy, all investments in ETFs—including active strategies—carry risks including equity, market, credit, liquidity, and others as detailed by fund providers. Investors are advised to read prospectuses, Key Investor Information Documents (KIIDs), and consult financial advisors before investing. Market conditions, regulatory changes, and global macroeconomic events can shift the dynamics of both costs and performance at any time.

The ETF revolution is well underway. For those considering active ETFs, a nuanced and complete understanding of total cost of ownership is key to optimising returns and harnessing the full benefit of flexible, tradable investment strategies.