Building Portfolios in 2018: Passive, Active, and Active-Passive | Page 2 of 2 | ETF Trends

Lunt Capital manages strategies that rotate across various factors based on quantitative rules.  The Elkhorn Lunt Low Vol/High Beta Tactical ETF (LVHB), in which Lunt Capital has an interest as the index provider, tracks the Lunt Capital U.S. Large Cap Equity Rotation Index, calculated by S&P Dow Jones Indices.  This index rotates between the 100 lowest volatility stocks and the 100 highest beta stocks within the S&P 500.  This index has two dynamic layers—the first layer follows rules that select the securities that qualify as “low volatility” or “high beta.”  The second layer follows rules to rotate between the two factors.  This is the ETF industry’s first factor rotation ETF, yet it technically qualifies as a passive ETF.

 The degree of active rules within an ETF continues to expand, as shown by ETFs from Innovator ETFs and Goldman Sachs ETFs.  The Innovator IBD 50 ETF (FFTY) tracks the Investors Business Daily 50 Index. FFTY incorporates both fundamental and technical rules for buying and selling the underlying securities.  It also incorporates the ability to move to 50% cash.  The Goldman Sachs Hedge Industry VIP ETF

(GVIP) tracks the GS Hedge Fund VIP Index, which is described as following the “fundamentally driven hedge fund managers’ ‘Very-Important-Positions,’ which appear most frequently among their top 10 long equity holdings.”

 Two interesting ETFs fit in the “Active-Passive” category that offer the ability to move to cash based on very different sets of rules.  The Pacer TrendPilot U.S. Large Cap ETF (PTLC) moves to 50% cash if the S&P 500 Index closes below its 200-day moving average for five consecutive days.  It moves completely to cash if the 200-day moving average is lower than its value five days earlier.  The WisdomTree Dynamic Long/Short U.S. ETF (DYLS) takes a fundamental approach to hedging.  The long portfolio of 100 stocks is rebalanced quarterly, based on fundamental criteria.  The short portfolio is a dynamic hedge of 0%, 50% or 100% using S&P 500 derivatives, and is based on growth and value factors.  Most advisors and investors would not care if these ETFs are technically passive—they are used within an asset allocation for their active, tactical characteristics.

Active ETFs with discretionary portfolio management or “Active”

2017 saw tremendous growth in truly active ETFs, and we expect this growth to continue in 2018.  Active ETFs provide access to talented, discretionary managers within the transparent and tax-efficient structure of an ETF.  Active management offers the opportunity for diversification away from inexpensive, efficient market beta.  Examples include the Ark Innovation ETF (ARKK), managed by a team of researchers and active stock pickers.  The managers focus on themes in genomics, web, and industrial innovation.  Davis Funds, the storied active money manager, launched a series of three active ETFs during 2017.  The Davis Select Financial ETF (DNFL) provides exposure to Davis’ high conviction ideas in one of their areas of expertise.  These two ETFs offer access to relatively concentrated exposure to successful active equity managers.  J.P. Morgan received the 2017 award for best new active ETF for its unique and compelling Diversified Alternatives ETF (JPHF).  Although it is filed as an active ETF, it uses a rules-based approach to provide exposure to equity long/short, event driven strategies, and macro-based strategies.  The definition of active varies across the spectrum of active ETFs!

Concerns about the potential for rising rates, a flattening yield curve, tight credit spreads, and currency uncertainty has brought actively-managed fixed income ETFs into the spotlight.  State Street has provided access to one of the bond market’s titans through three ETFs actively managed by DoubleLine.  The SPDR DoubleLine Total Return Tactical ETF (TOTL) and the SPDR DoubleLine Short Duration Total Return Tactical ETF (STOT) utilize DoubleLine’s active security selection and sector positioning to provide fixed income exposure that looks very different from traditional benchmarks.  First Trust has been a leader in the active ETF space, and 2017 saw the launch of the First Trust TCW Opportunistic Fixed Income ETF (FIXD).  This brought TCW’s value-oriented fixed income approach to ETFs.  Last, the J.P. Morgan Global Bond Opportunities ETF (JPGB) leverages the firm’s impressive global platform to bring active management to global bonds in an ETF wrapper.

While many in the industry have framed the issue as “active OR passive,” we embrace a philosophy of “active AND passive.”  We believe that the “active-passive” category also plays a valuable role.  Categories and definitions are less important than understanding the construction, attributes, and characteristics of each ETF, and the role it is expected to play within an asset allocation.  In our view, having such a vast spectrum of ETF available makes us enthusiastic about managing portfolios in 2018, regardless of political, economic, and market conditions.

John Lunt is the President of Lunt Capital Management, a participant in the ETF Strategist Channel.