Active trading in exchange-traded funds, or ETFs, can generate a lower amount of risk and provide returns from other asset classes.
Adding actively traded ETFs can be one strategy to diversify assets in a portfolio. These funds typically serve two goals: to provide investors with a vehicle that aims to outperform a benchmark or to give access to niche parts of the market, says Mike Loewengart, managing director of investment strategy at E-Trade Financial, an Arlington, Virginia-based brokerage company.
ETFs are similar to mutual funds since a portfolio manager selects the assets in the fund, but investors should expect higher expense ratios than a passive ETF.
“As with any actively managed investment, investors should consider the portfolio manager’s track record to assess whether it’s worth the additional expense,” Loewengart says. “Since actively managed ETFs are relatively new, performance records could be light. If the manager has a longer record with other vehicles such as a similar mutual fund or separately managed account, it can provide insight into how their newer ETF may perform.”
One advantage of ETFs is that they are traded on an exchange, allowing investors to add or lower the number of shares during normal market hours.
“Consider that actively managed ETFs could provide value in taking advantage of market trends or more opaque areas of the market like fixed income or international,” he adds.
Investors who want to take advantage of the volatility in the market can sell an ETF or stock at its higher price and buy again at a lower price without changing the percentage they allocated to the asset, says Jason Spatafora, co-founder of marijuanastocks.com and head trader at truetradinggroup.com. They could allocate 10% to 15% of a portfolio in actively managed ETFs or other assets.
“It allows them to keep better track of their holdings and grow positions without putting more money into the trade,” he says.
Before you invest in actively managed ETFs, here are a few key points to understand:
— The benefits of actively managed ETFs.
— How active management compares with passive strategies.
— Sectors that benefit from active management.
The Benefits of Actively Managed ETFs
Many thematic ETFs could add additional performance through active management by “being more nimble around changes in the investment dynamics within a sector, asset class or industry group, or whatever the ETF is focused on,” says Timothy Seymour, founder of Seymour Asset Management in New York and portfolio manager of the Amplify Seymour Cannabis ETF (ticker: CNBS).
Several newer sectors benefit from actively managed ETFs, such as marijuana since there are fewer public companies, but investors should consider the experience of the portfolio manager in trading active strategies.
“As a portfolio manager who is running an ETF in a rapidly evolving industry like cannabis, being active means I can avoid corporate governance red flags and either sell or not own companies I think are raising risks,” he says.
Another advantage for portfolio managers is that they can also own a percentage in new deals, says Seymour, who could immediately take advantage of an initial public offering in December instead of waiting for a rebalance in the ETF.
Portfolio managers can also benefit from the ongoing mergers and acquisitions activity in the cannabis industry where some companies will be consolidated or create catalysts.
“When the market sees strong macro factors, I can allocate to higher beta companies which will benefit more in price action,” he says. “When there was a bear market, I was able to allocate to defensive subsectors within cannabis or special purpose acquisition companies (SPACs) that were lower volatility because of their structure.”
Active managers can adjust to major moves when a stock goes up or down, since they can add to positions that become more interesting on price or sell down positions that become less attractive, Seymour says.
In cannabis investing, the largest ETF is the ETFMG Alternative Harvest ETF ( MJ), which is passively managed and is generating a year-to-date return that is down around 9%, while Seymour’s ETF, CNBS, which is an active strategy, is up more than 30%. All of the other nonderivative cannabis ETFs are negative on the year, Seymour says.
Actively managed ETFs can generate higher or lower returns than passively managed ones since portfolio managers can choose stocks or bonds based on “specific views that may differ from index positions in passive ETFs,” says Jodie Gunzberg, managing director, chief investment strategist at Morgan Stanley, Wealth Management Institutional.
How Active Management Compares With Passive Strategies
“Active strategies may also more effectively manage risk by limiting position sizes and sector weights or by intentionally taking positions to contribute to risk in a meaningful way,” Gunzberg says. “If actively managed ETFs are less correlated to passive ones, it is likely a result of their different holdings.”
Active bond strategies are usually more attractive than passive ones since there is a wider universe of bonds issued compared to stocks, so the variety of strategies are numerous and transparency is less of a challenge for the managers, she says. Passive bond strategies are generally constructed in a way that results in the largest positions in issuers with the most debt, which is not necessarily an advantageous position.
Bonds can be more illiquid with distinct data pricing sources that can create opportunities for attractive execution relative to passive strategies, she says. Active bond portfolios can more effectively manage income goals, duration risk or interest rate sensitivity, credit and default risk, as well as other risks similar to equities, such as sector and position concentration.
Sectors That Benefit From Active Management
Sectors with higher volatility and dispersion generally benefit more from active management as well as ones with very large companies that can dominate the sector in market-cap weighted strategies, Gunzberg says.
International and emerging market equity strategies are generally better actively managed than passively managed since portfolio managers who are familiar with local issues could add value in selecting securities.
The main reason for investing in active funds is to get alpha, a return greater than the benchmark index, says Anthony Denier, CEO of Webull Financial, a New York-based trading company.
“This makes it hard to gain a pricing advantage and almost impossible to consistently ‘beat the market,'” he says. “This is pretty much the state of today’s U.S. stock market. There are many studies showing that, in general, actively managed equity funds don’t outperform their benchmark or passive funds on a consistent basis.”
The U.S. small-cap stocks market can be less efficient than U.S. large-cap stocks, and emerging markets are definitely less efficient, Denier says. ETF managers with better information on price inefficiencies have an advantage and a greater chance to profit.
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