Active ETFs Give Managers New Tools for Portfolio Control

Active ETF managers are using the investment vehicle's structure to have more control of a portfolio and improve risk management compared to traditional passive and mutual funds.

The evolution toward active ETFs represents a natural progression as investors seek more sophisticated solutions beyond basic index exposure, according to Fritz Folts, chief investment strategist at 3EDGE Asset Management.

As market volatility and economic uncertainty persist, active ETFs are gaining traction by combining professional management with ETF structural advantages that can provide enhanced risk management, tax efficiency, and flexibility compared to both passive ETFs and mutual funds, Folts said.

"Investors are looking for more than just pure passive exposure to asset classes. They want greater customization and flexibility," he said. "It's less of a blunt instrument."

Active ETFs and Risk Management

Active managers can provide more exact control over portfolio risks compared to passive strategies, Folts explained. Rather than simply tracking an index, managers can adjust exposures and implement specific risk parameters.

"In an active ETF format, we can be far more precise in terms of risk management. We can decide exactly how much downside we want to protect against, how much upside we want to capture," Folts said.

The ETF structure offers tax advantages through the creation and redemption mechanism, Folts noted. This can help reduce capital gains distributions compared to mutual funds, with the benefits "dropping right to the bottom line" for investors, he explained.

Fixed income has emerged as a particularly strong area for active management, according to Folts. Rather than trying to replicate complex bond indices with thousands of securities, active managers can tactically adjust duration and credit quality based on market conditions.

"Those decisions about duration, credit quality–in a passive vehicle, they all fall to the investor," Folts said. "By hiring a portfolio manager, you have an investment professional who has taken on that burden."

This flexibility has become more valuable as the 40-year bull market in bonds appears to be ending, Folts noted. "We have a very strong suspicion that those days are gone," he said of the extended period of falling rates that made passive bond investing relatively straightforward.