As ETFs rose, it seemed to be normal that some market observers tried to discredit these products by raising (wrong) concerns. I don’t want to speculate about the motivation of these authors, but in most cases the accusations made in the respective articles, blogs, or market comments can be refuted quite easily. Since we currently witness the rise of actively managed ETFs, nobody should be surprised that there are some market observers out there who blame some of the actively managed ETFs to not be active enough.
Well, in the asset management industry the term, passive products are clearly defined as products which follow an index by holding the same constituents as the index at the same weight as the index all the time. This means the portfolio manager does make any decision about the securities in his portfolio or their weighting. Conversely, the term actively managed portfolio does leave a lot of room for speculation about what “actively” exactly means. If it is the opposite to “passive,” then any portfolio where the manager can make decisions about single securities and/or their weighting in the portfolio has to be considered as actively managed.
That said, the critiques are saying that the so-called research enhanced ETFs are not actively managed, since they do follow their indices very closely, hence they do only take small bets in an attempt to outperform their underlying index. From my point of view, this is active management, which follows restrictions that are clearly outlined in the respective legal documents. However, there are also actively managed ETFs which claim that they do not follow an index as their portfolio is built based on a discretionary decision-making process. Opposite to the research enhanced ETFs, these ETFs can have very concentrated portfolios which create the chance of a large outperformance to a given market (index) but do also bear the risk of a massive underperformance.
To separate the former from the latter, investors must do their homework and take a look into the respective documents. Selecting an actively managed ETF has to follow the same process as selecting an actively managed mutual fund. By the way, there are a lot of mutual funds which are managed very closely in relation to an index but do state that they are research enhanced index products. This means that investors need to be even more careful when selecting active managed mutual funds than ETFs, since most of the latter can be identified by the product name.
Unfortunately, the more products that are available to investors, the higher the complexity of a market gets. This means the days where it was easy to pick an ETF for a given portfolio are over, especially when it comes to actively managed ETFs.
With regard to this, it might be worthwhile to discuss if a research enhanced ETF is truly actively managed or not. But actually, this is a more theoretical discussion, as the suitability of the management approach of an ETF is defined by the needs of an investor.
In reality, investors decide about the future of new products, as they are voting with their money, and if an ETF or a group of ETFs is able to gather significant amounts of money, these products can’t be too worse. In the example of actively managed ETFs, I would assume that most of the money which is invested in these is from institutional/professional investors who do exactly know what they are doing. If these investors prefer to invest in an investment strategy, which is closely tied to an index, then they are doing it for a reason. From my point of view, this reason is that the respective institutional/professional investors want to keep their portfolios as close to their target index as possible and use research enhanced ETFs to have the change of a small outperformance, without the risk of a massive diversion in terms of the regional or sector allocation from the index. In addition, they may want to minimize a possible underperformance to the index caused by discretionary decisions of a portfolio manager.
Like actively managed mutual funds, not all actively managed ETFs do follow the same approach when it comes to the management and construction of their portfolio.
Once again, the suitability of the management approach of an ETF is defined by the needs of an investor.
The views expressed are the views of the author, not necessarily those of LSEG.
This article is for information purposes only and does not constitute any investment advice.
