Investment Ideas

ETFs Explained #4: Why active management in ETFs matter?

ETFs Explained #4: Why active management in ETFs matter?
Published: 12/08/2024

Investors typically tap into active exchange-traded funds (ETFs) to solve for a variety of investment challenges. The active ETF market has become as diverse as the active mutual fund market, presenting a wide array of strategies spanning asset classes and strategies that cater to a range of investment needs. This has helped position active ETFs as a viable and important portfolio building block.

With the take up of the instrument surging, we detail the reasons why some investors are opting for active ETFs.

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A blend of both worlds

Active ETFs aim to combine the skill and expertise of active portfolio managers with the efficiencies of exchange listed vehicles. Active ETFs also typically provide investors with active strategies at a relatively lower expense ratio or fee.

“Active Management” refers to investment strategies, which are designed to seek specific outcomes, such as outperforming an index (alpha), generating potential income, or providing investors with flexibility in terms of duration, yield and/ or credit quality. These strategies make them quite different to their passive counterparts, which aim to track a designated benchmark such as the S&P 500 Index or the Bloomberg Global Aggregate Fixed Income Index as closely as possible.

Active ETF managers – typically comprised of experienced portfolio managers and a team of research analysts – undertake their own fundamental or quant analysis and use this analysis to drive an investment view, or to target a factor, or combination of factors. This flexibility may help investors achieve their goals, such as sophisticated portfolio construction, outperformance or reduced volatility.

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Greater variety of investment options

Active ETFs are designed in a way that they can go beyond the limitations of market-cap indices that passive ETFs track. By simply tracking an index, passive ETF will likely invest in the bigger companies in an equity index and the bigger debt issuers in a bond index as they constitute a higher percentage of the index.

On the contrary, active ETFs present a greater variety of investment options, in the form of strategies reflecting specific company level research, and investment flexibility to take advantage of temporary mispricing in the market. Active ETF managers have the ability to access the entire equity and bond markets, opening up the potential for capturing opportunities to manage risk and add alpha.

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Nimble and flexible

Active managers are not beholden to index weights or index rebalancing. They can instead undertake their own analysis to pick investments. In addition, they can be nimble to help manage the portfolio. Managers of active ETFs can position a portfolio in response to the business cycle and reallocate investments to insulate their strategies from shocks during periods of volatility and take advantage of opportunities to boost returns.

Active management of ETFs is becoming an effective and essential modern portfolio construction technique. With the growth in the number of such ETFs, investors now have the option to select active ETFs that reflect their market conviction, and tap active managers who have access to sophisticated resources and deep research insights. The nimbleness and flexibility add to the allure of the instrument and may make it an all-weather portfolio tool in an investor's portfolio.

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