ETFs: Not Just for Indexing Anymore

ETFs: Not Just for Indexing Anymore

Interest in active ETFs continues to accelerate.

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Reviewed by: Lisa Barr
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Edited by: Lisa Barr

On the same day BlackRock launched a pair of active exchange-traded funds, my industry colleagues and I were considering the same issues that BlackRock likely mulled before it launched those funds: whether or not the era of active ETFs had arrived.  

Earlier this week, I led a panel that basically confirmed active ETFs are indeed firmly established among investors and advisors. 

For the second straight year, I hosted a panel on active ETFs at the Inside ETFs conference in Hollywood, Florida. The 40-minute, fast-paced discussion, titled “The Role of Active ETFs in Managing Volatility and Generating Alpha,” brought together a group of four investment industry veterans, including two active ETF managers who each approach the active ETF space from a unique angle.  

As with the better-known, original passive index variety of funds that debuted 30 years ago, now that the spigot has opened, with firms large, small and in between launching products at an accelerated pace, investors can formally add another dimension to their research efforts.  

Multiplier Effect 

Active ETFs now account for more than 1,100 tickers and a rapidly widening array of strategies. That implies a multiplier effect of sorts when it comes to understanding them, differentiating between them, and determining if and how to use them to complement other parts of alpha-driven portfolios. 

Commenting on the disruptive events of 2022, in which stocks and bonds fell together, Scott Peng, founder of Advocate Capital, and manager of the Advocate Rising Rate Hedge ETF (RRH), noted that “for years, correlation between stocks and bonds was more of a straight line, but now we’ve lost that diversification impact of bonds within your portfolio. This is something people should start paying attention to, if this is a new paradigm.” 

That point was seconded by Vincent Lorusso, who manages a pair of ETFs at Changebridge Capital, the Changebridge Long/Short Equity ETF (CBLS) and the Changebridge Select Equity ETF (CBSE).  

“There’s a lot of talk about the market’s adjusting to the end of 14 years of free money (i.e., near-zero interest rates) leading to tremendous consumption of debt.” he said. “But what about adjusting to the end of a 40-year cycle where interest rates went down?”  

Lorusso also questioned whether traditional diversifiers such as private equity and commodities will continue to play that role as well as they have in the past.  

Malik Sarwar, senior partner and managing director of Wealth Management at Global Leader Group, invoked the late Vanguard founder Jack Bogle when he talked about how “investors like things kept simple, and ETFs are simple. That’s why ETF assets are moving higher and mutual fund assets are moving lower, essentially in a 1-for-1 ratio. It’s also why many of the large mutual fund companies are now entering the ETF business.” 

Becky Lightman, founding partner of Lightman Capital, a wealth management firm in Boca Raton, Florida, operates within a registered investment advisor structure but transitioned there following many years in bank and trust firms.  

Limited Allocations 

I asked her how those two types of firms are likely to approach active ETFs going forward. “RIAs will be very flexible and creative, and many will want to get their alpha through active ETFs,” she noted. 

Lightman added that modern markets may test the somewhat rigid nature of investment allocation plans at larger institutions, and that such firms “are more likely to pass on active ETFs, or choose to develop such products themselves. A lot of the current group of active ETFs are smaller in size, which limits how much big firms can allocate to them.” 

Indeed, less than 200 active ETFs (less than 20% of the total roster) have more than $250 million in assets. That in part reflects the relative newness of these vehicles, as more investment firms transition from managing actively in mutual fund form and gravitate toward the more tax-efficient ETF structure.  

While a small number of active ETFs such as the JPMorgan Equity Premium Income ETF (JEPI) and the ARK Innovation ETF (ARKK) have amassed very large portfolios in a relatively short period of time, the active ETF universe is largely populated by innovative, though less “discovered,” investment strategies.  

Based on the popularity of this session and the sentiments of the thought leaders who joined me on the panel, it appears that will not be the case for long.  

Rob Isbitts was an investment advisor for 27 years before selling his practice to focus on ETF research and education. He is based in Weston, Florida. Contact him at  [email protected] and follow him on LinkedIn.