Combine Active, Passive ETFs to Make a Stronger Portfolio

Before filling out an investment portfolio, ETF investors should consider the best practices in portfolio construction and potentially look to actively managed strategies to enhance a portfolio consisting of cheap, passive index funds.

On the recent webcast (available on demand for CE Credit), Active or Passive? Why You Should Use Both!, Matthew Bartolini, Head of SPDR Americas Research for State Street Global Advisors, painted a picture with a changing landscape as index-based funds garner a greater market share at the expense of actively managed funds. Active funds took up 87.5% of the overall investment market share back in 2001, but as of 2017, active funds made up a smaller 63.2% slice of the market.

ETFs have been a huge contributing factor to this shift toward passive index-based fund investments. For instance, in 2017, U.S.-listed equity ETFs attracted $334.6 billion in net inflows and fixed income-related ETFs brought in $127.4 billion in inflows.

Low-cost, passive index-based ETFs have been gaining momentum at the expense of active funds. However, it is also surprising that active funds continued to see assets shrink, especially as 48% of large-cap active managers outperformed in 2017, the highest percentage in eight years.

“The active environment has improved in 2017 as stock correlations collapsed to 15-year lows and dispersions started widening again,” Bartolini said.

“Decoupling sector correlations and above average dispersions point to a constructive environment for sector rotation strategies,” he added.

Bartolini also pointed out that active managers have performed better in certain asset categories. For instance, a lower percentage of active managers underperformed benchmarks in emerging market equities and foreign large blends.

Looking at fixed-income categories, a lower percentage of active managers underperformed in global fixed-income and investment-grade intermediate funds. Bartolini argued that it is better to “select active managers with expertise in less efficient sectors to add additional diversification.”