Actively managed exchange-traded funds are having a moment, but it’s not going to be a passing fad.
This year alone, a record number of ETFs have been introduced, with 288 new funds and the potential for over 1,000 new ETFs by this year’s end, many bringing actively managed strategies from the traditional mutual fund world to ETFs. There are currently more than 2,000 active ETFs, and while they only make up about 10% of total ETF market assets, they have taken in over one-third of the flows this year from investors and reached the $1 trillion mark in total assets this year.
ETF experts say as more major fund companies add actively managed portfolios, it will help to shape the ETF industry’s long-term future. Case in point is the biggest index fund company of all, Vanguard. Vanguard has launched eight active fixed-income ETFs.
Roger Hallam, Vanguard global head of rates, cites these strategies in being integral for generating repeatable returns for clients.
“We’re very focused on delivering bottom-up security selection to ensure that our alpha generation is as high information as it can be, so that we deliver repeatable returns for our investors over the investment cycle” Hallam said on a recent CNBC “ETF Edge” segment.
The Vanguard ETFs include an ultra-short treasury ETF (VGUS), a 0-3 month T-Bill ETF (VBIL), a short duration bond ETF (VSDB), and a long-term tax exempt bond ETF (VTEL) amongst others.
ETF experts caution that there is a big difference between adding active strategies to add return potential around a portfolio core of index holdings and becoming market timer, with the latter still a mistake too many investors make when markets are volatile.
Active fixed income strategies have allowed managers to be more surgical in approach to a bond market which has faced high and atypical levels of volatility, and in light of the fact that the big traditional index from the bond market, the AGG, is considered by many bond experts to be out of date in its composition (the same would not be said of the S&P 500 for stocks). In the equities space, some of the newest active approaches are designed to limit risk in the stock market rather than ratchet risk up.
Amid a year which already experienced one huge market drop, it’s important for investors to not over-correct based on short-term swings in performance. But active strategies make sense in ETFs, according to BlackRock‘s U.S. Head of Equity ETFs Jay Jacobs, for reasons that go beyond the recent bond and stock market volatility.
“You’ve seen hundreds of billions of dollars pouring into ETF models that are scalable, repeatable, and cost efficient. And increasingly those models are adding active strategies to introduce new sources of alpha for their clients. So, there’s a lot of tailwinds,” he said, adding that the tax-efficient nature of buying and selling within ETFs is another benefit contributing to the adoption of active ETFs.
“Previously, strategies that maybe were harder to access, or there was investment minimums, or the tax efficiency meant they could only be used by institutions that were tax advantaged, that has largely gone away with active ETFs” Jacobs said. “The world has shifted a lot in the last few years,” he added.
The ETF experts also say that investors may seek more return generation from active approaches if the last decade of market returns proves to be unrepeatable. The ultra-low interest rate policies from the Federal Reserve which boosted the performance of the stock market in particular are not expected to return, and that has implications for what investor can expect from their core holdings. The shift to more of these active strategies marks not only a significant change in how asset managers are tweaking their ETF portfolio lineups, but in how investors are approaching the market.
Watch the video above to learn from from Vanguard and Blackrock.
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