How ETFs can be used to implement active strategies
For most of their history, ETFs were purely passive products – tracking a market such as the S&P 500 or gold as closely as possible for a low fee. But recently, companies have launched active ETFs – where money managers make decisions on what to buy and sell, like a traditional investment fund. 🧲
Why would anyone do that?
A bit of action gives the ETF the potential to beat the performance of the wider market. However, many academic studies have shown that **passive tracking beats the majority of active managers eventually (SPIVA®, 2020)**❗ While more expensive than their passive cousins, active ETFs also generally offer lower fees than traditional funds.
Are there other ways to beat the market?
Some ETFs sit halfway between passive trackers and active stock-pickers – these are known as “smart beta” ETFs and have grown in popularity since first hitting the market a decade ago. Smart beta ETFs use computer-defined 💻 rules to pick investments with certain qualities (known as factors) rather than a human asset manager’s judgment.
Popular factors include:
- value: buying stocks that are cheap;
- momentum: buying winning stocks that have recently outperformed;
- size: buying stocks that are small;
- volatility: buying stocks with lower price swings.
Over the long term, stocks meeting these criteria have historically risen slightly more than the market as a whole (though that’s no guarantee it’ll happen in the future). 🔮
How does this work?
The theory is that factors exploit investors’ human failings, which direct more money than is justified to certain stocks – like favouring glamorous companies with fast-growing profits over cheap ones or plumping for the biggest names in a sector over smaller “hidden gems”.
That’s it! Check back next time when we’ll talk about how to construct an ETF portfolio. 🙏🏼
Remember that when you invest, your capital is at risk. This learning guide is for information purposes and is not investment advice. Past performance is not an a guarantee of future returns.