An investment advisor is evaluating two ETFs for a client's core Canadian equity allocation. ETF A is a physical replication ETF holding all constituents of the S&P/TSX 60 Index. ETF B is an actively managed ETF that aims to outperform the same index by employing a fundamental research-driven approach. What is a key structural difference that would typically allow ETF B to potentially generate alpha, unlike ETF A?

Question: An investment advisor is evaluating two ETFs for a client's core Canadian equity allocation. ETF A is a physical replication ETF holding all constituents of the S&P/TSX 60 Index. ETF B is an actively managed ETF that aims to outperform the same index by employing a fundamental research-driven approach. What is a key structural difference that would typically allow ETF B to potentially generate alpha, unlike ETF A?

Answer options:

• A. ETF B's ability to engage in securities lending for additional income. ✅ B. ETF B's portfolio manager making discretionary investment decisions.
• C. ETF B's lower transaction costs due to less frequent rebalancing.
• D. ETF B's exemption from quarterly disclosure requirements applied to ETF A.

Correct answer: B. ETF B's portfolio manager making discretionary investment decisions.

Explanation: Active ETFs employ a portfolio manager who makes discretionary buying and selling decisions based on research and market outlook, aiming to select securities that will outperform the benchmark. This active decision-making process is the primary mechanism through which an active ETF attempts to generate alpha, unlike a passive index-tracking ETF.