When it comes to Exchange-Traded Funds (ETFs), there are typically two management approaches: active investing or passive investing.
Passive investing is an investment strategy that tracks a given index over the long-term, involves limited daily management of the portfolio and often comes with lower fees. With active investing, portfolio managers monitor the portfolio regularly and buy and sell based on how the market is performing, in an effort to outperform a benchmark and better control risk.
When does active investing make the most sense?
Evolve ETFs’ President and CEO, Raj Lala, and Ryan Domsy, Vice-President & Portfolio Manager – Fixed Income at Foyston, Gordon & Payne, Inc. (“FGP”) discuss the main benefits. FGP is the sub-advisor to the Evolve Active Core Fixed Income ETF (FIXD) and the Evolve Active Canadian Preferred Share ETF (DIVS).
1. Where is active investing increasing in popularity?
Lala: Active ETFs have been growing at a rate of about 40 per cent a year for the last five years. More financial advisors and direct investors are seeing the value of active management in the ETF space. When we started Evolve, we wanted to focus on active management for certain asset classes like preferred shares or emerging markets. Active management makes a ton of sense from a risk and return perspective as investors may benefit from superior stock selection through investment process and risk management. About 20 per cent of assets in the ETF space are actively managed.
Domsy: Where active investing makes the most sense is in markets where passive investing actually forces increased risk-taking. A more complex marketplace usually brings with it more inefficiencies, like lack of information on certain companies. Financial managers can take advantage of these inefficiencies to get better returns. Typically active management can be used in any environment.
2. What are the benefits of active management in ETFs vs. mutual funds?
Domsy: While you are starting to see certain mutual fund companies decreasing their overall fees, ETFs are still typically going to be cheaper.
Lala: Another big point is that they are easier to transact for an advisor. This especially applies for fee-based discretionary advisors who like an ETF and want to spread it across their entire client base. It’s a lot easier to do that with an ETF than with a mutual fund, where they still have to do manual transactions.
3. When are investors better off with active management?
Lala: According to last year’s SPIVA report card, 93 per cent of Canadian equity funds that were actively managed underperformed their benchmark over the last year, 91 per cent underperformed over three years. So when you look at areas like the Canadian equity market, odds are that you’re better off owning a passive ETF. But if you look at the fixed income market, there are areas like duration and indebtedness that active management can really help better returns by reacting to and anticipating external factors.
Domsy: Yes, I think it also allows strategic control, which is incredibly valuable. For instance, even now, as we enter into potential trade wars, good active managers have started to position themselves more towards companies that are getting the majority of their growth domestically. Those types of decisions and analysis can provide advantages in the market. For example in a rising rate environment, active management for fixed income can help investors better realize their goals by managing portfolio risk while enhancing returns.
4. Can you explain a little further about the advantages of active management in areas like core fixed income and preferred shares?
Domsy: Active management is uniquely important to the fixed income space—made up of bonds and preferred shares—because of the complexity of individual securities. For both bonds and preferred shares, the most important feature of active management is that you can avoid the debt of companies that are becoming a larger portion of an index. Passive investors automatically have to hold the debt of the company until a rebalancing period.
5. What does a good active manager do in this case?
Domsy: Avoid the companies where these higher debt loads are increasing the risk profile, so as a result, the portfolio is actually safer. A lot of people think active management is all about enhancing the returns, but often times what we do is focused around limiting risk and keeping the overall portfolio safer. Active managers have the ability adjust their sector allocation and better position portfolios to minimize the impact from rising rates.
This content was produced by The Globe Content Studio. The Globe and Mail’s editorial department was not involved.
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