Intro

In part one of this blog, I wrote about:

• The phenomenal take-up rate of Exchange Traded Funds (ETFs)

• The growing popularity of Actively Managed (AM) ETFs here and abroad

• What Actively Managed ETFs are and how they differ from index funds

In this part, I am going to cover:

• My thoughts on why so many Active ETFs are being introduced

• What attracts investors to Active ETFs

• What I look for in an AM ETF

• The best place in your portfolio to use them

• How to make the most of AM ETFs

Why are so many actively managed ETFs being introduced 

If I’m to believe the press the reason for the sudden influx of Active Managed ETFs is down to investor demand.  There might be some truth to it, but I’m not entirely buying it. Mainly because I’ve never had one investor tell me that their life would be better if there were more active ETFs in the world. I concede I could be wrong.

For me, the main reason why more active ETFs are becoming available is that traditional fund managers were losing market share to Exchange Traded Funds.  Check the stats.  Managed fund use is decreasing at a rapid rate of knots while we know ETF use is exploding.  The old saying “if you can’t beat them,  join them” comes to mind.

The convenience of ETFs means DIY investors can easily access them.

On top of that more advisers as using them in their recommended portfolios.  The ability to bypass application forms,  an investment platform, or more importantly platform fees, and just purchase the ETFs with a share broking account certainly helps. Especially for Self-Managed Super Funds.  

Quite simply for fund managers to stay relevant they had to get on the listed band wagon.  Regardless of the reason behind the sudden influx I can see why investors would find AM ETFs attractive.

Why would an investor be attracted to an Actively Managed ETF       

Even though I started using ETFs to get away from active fund managers I’m not totally against AM ETFs, in fact I think there are a variety of reasons why investors may find actively managed products appealing.

I believe it is perfectly reasonable for an investor to think that a fund manager  employing highly educated stock pickers – analysts that do nothing other than live and breathe the stock market - should be able to beat a humble index fund. 

Let’s face it, we humans like bells and whistles, we don’t like being bored and we often feel the grass is greener on the other side.  So, if the choice is between a boring index fund that does nothing other than track an index or an active fund manager fund promising to do it  better  – many investors are going to go an active manager.

Of course, they would be wrong but that’s a topic for another blog.  Let’s look at some other valid reasons

Some valid reasons to consider an AETF       

As I said I’m not totally against Active ETFs, they definitely have their place and there are valid reasons why an investor would use - and for that matter why an adviser would recommend - them in a portfolio. 

For me it comes down to saving time by letting an expert manager in a complex area help me target a specific strategy.

To make it real I will use an example.

When creating the defensive / income part of a client’s portfolio I often used Betashares Active Australian Hybrids Fund (HRBD).  The ETF deals with Hybrid Securities.  If you’ve never come across a Hybrid investment before it’s an investment that combines elements of debt securities (e.g. bonds) and equity securities (e.g. shares).  Hybrids typically pay a higher level of income than bonds which is why I used them. 

This is a complex area and there are a lot of Hybrids out there.  As one adviser I can’t get my head around all the options available. This is where professional insight into specific area can make the difference. 

Using a manager that’s an expert in the field saves me a lot of time. I don’t have to research the specific investment area or every underlying investment within the ETF.  In this case I’ll gladly pay the management fee to let an expert in the field handle the decision-making.

My goal by using the fund is to create extra income for the portfolio. An allocation into Hybrids allowed me to do so. Using an ETF meant I didn’t have to research to many investments.

So what do I look for in an Actively Managed ETF

When I'm considering an AM ETF, (apart from the basics that you would look at in any investment), there are a few key things I always look for.

First and foremost, I don’t want an index hugger —this is a manager who basically replicates an index and then makes one or two tweaks to the portfolio and hopes for the best. If that’s the case, I might as well just buy the index myself. I saw this far too often in the past with Australian large cap fund managers. When you took the time to look at the underlying investments you would find that, in both stock choice and proportion held, the top ten holdings looked suspiciously liked the index.  Yet they were changing 5 times more!  No thank you.

Another related factor for me is high conviction—what I mean by this is I prefer managers who concentrate their investments in a smaller number of stocks they really believe in, rather than spreading the risk thinly across too many.   If the manager is an expert at picking investments in a particular area I want them to invest in the best of breed -  not invest in so many that their returns get diluted.

And I definitely don’t want them holding a bunch of cash—I’m not paying an active manager for asset allocation; I’m paying them to be fully invested and give it a red hot go.  If they get it wrong for a while I will have patience with them but I am not going to pay them to be in cash. 

As I alluded to previously, I  tend to choose active ETFs that  focus on complex areas that I can’t easily replicate or research on my own.  If I believe the area is worth investing in but it would take too much time and effort to get my head around it,  I might as well employ a manager to do the heavy lifting for me.

In short, if I am going to use an actively managed ETF I want a fund that offers a real point of difference from the index funds I already hold.

Where to use an active Managed ETF in your portfolio

If an investor truly believed that active managers would achieve their mandate and consistently beat the index funds, they’d be tempted to use active managers for their whole portfolio.  But If you’ve read any of the research you would know that beating an index is tough for any active manager, and doing it consistently is even tougher. 

If you’re considering an active manager, it’s important to think about where they fit into your portfolio.

For me, the most obvious place for an Active manager is in the Satellite part of a Core /Satellite portfolio.

If you haven’t heard this term before a Core/Satellite portfolio basically has most of its allocation into cheap, broad based index funds - its Core so to speak  - and then takes a more specific or tactical approach to its other investments - its Satellites. The Satellite investments can be in a specific regional area, a particular industry or investment style or an active manager.

Active management can make a difference when navigating more complex or dynamic sectors. If you're looking for that extra layer of expertise or aiming to get more specialized, an active ETF can be a smart choice. However, you might not want to take your classic buy and hold approach with your satellites.

Making the Most of Actively Managed ETFs

When using an actively managed ETF, it’s important to remember that you’re investing as much in the manager’s expertise as in the actual investments they choose. You’re trusting their skills to navigate the market and make decisions that can outperform the index.

But a “set and forget” approach might not be the best strategy here. Instead, you may need to manage the manager so to speak —keeping an eye on their performance and being ready to make adjustments if needed.

There will be times in a market cycle where an active manager should be able to outperform the index, but those windows are rare. When they do arise, it’s important to act decisively and take advantage of the opportunity.

Ultimately, actively managed ETFs can offer real benefits, but they require a bit more attention and strategy than a typical index fund.

If you would like to discuss any of the ideas raised in this blog, contact me.

This blog’s aim is to provide general information only.  It should not be relied upon as personal financial advice.  While all care was taken at the time of writing I make no representations as to the accuracy, completeness, suitability, or validity, of any information contained within.  I strongly recommend investors consult a financial adviser prior to making any investment decision.