Active, passive, or somewhere in the middle

Active ETFs, which use a process to select securities that is not rule-based, have begun to increase in both number and assets over the past several years, but they remain a small part of the market.

Active ETFs represented around $45 billion of assets at the end of 2017, or about 1.3% of the total ETF market.

The growth and popularity of these strategies is primarily in line with the increasing use of ETFs by retail investors and financial advisors who have long utilized active strategies through mutual funds. As ETFs continue to slowly replace mutual fund in investors’ portfolios, it makes sense that active ETF strategies keep gaining popularity.

While active ETFs are still a small universe of the ETF world, their break down is interesting, with about $35 billion, or the vast majority, of them being fixed income active ETFs.

“The majority of those active ETFs are fixed income and what that says is that there’s some hesitancy among advisors to use fixed income ETFs because active management works really well at a lot of intermediates,” says Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors.

“People who are hesitant in using index-based fixed income ETFs are sort of testing the water by using active fixed income ETFs. They’re still using that active strategy that they know so well, but then they’re also reaping the benefits that the ETF structure does have such as lower fees and also the secondary market.”

Should investors go with an active or passive ETF?

For Wisdom Tree, the answer lies somewhere in the middle.

“We tend to think of things less in the binary active versus passive,” says Joe Tenaglia, asset allocation strategist at Wisdom Tree. “We think you can really take elements of both in the ETF space and together it’s really improved investors’ experience.”

He explains that the same steps active managers have taken, both in the ETF and in the mutual fund space, can be boiled down to a couple of key tenants that managers can then turn into a rule-based, index-tracking process.

“We tend to think of the sweet spot being in between within an ETF wrapper,” he adds. “They are definitely strengths and weaknesses of both active and passive ETFs, we kind of try to fall in between there.”

One way to provide this in-between option is through smart-beta ETFs, which use alternative index construction rules including size, value and volatility, instead of the typical cap-weighted index strategy.

They are passive because they follow an index, and active because it adds other factors decided by the managers to maximize returns.

“We think those can act as lower-cost replacements for active managers,” says Tenaglia. “Because these are the types of ETFs that have the same objectives as the traditional asset managers in the traditional mutual funds that investors have used for generations. Because it’s tax efficient, transparent, liquid. We think it’s a better vehicle to help investors reach their long-term goals.”

With index-based ETFs continuing to represent the bulk of the ETF market and actively-managed strategies growing, albeit at a slower pace than some may have anticipated, it seems that hybrid, or smart-beta, strategies—the somewhere in the middle—may determine the future of the ETF market.

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