Envestnet's Game-Changing ETFs: The Best of Both Worlds for Investors

*One of the biggest debates continues to be whether passive or active management is better for investors. There are certainly pros and cons to both. More often than not, the kind of market dictates what kind of management style does best. However, most investors will stick to one choice for their portfolios.

But now, they can have their cake and eat it too.

Thanks to a new series of ETFs from investment manager Envestnet, passive and active strategies can be had with one ticker. By blending both passive and active management into one fund, investors don’t have to choose, and they could potentially win over the long haul. The funds also tend to spur copycats.

Active & Passive Work Well Together

Passive and indexing strategies have won investors over big in recent years as the creation and interest in exchange traded funds (ETFs) has surged. And there have been numerous studies supporting passive and index funds consistent outperformance versus actively managed mutual funds.

But the truth is, active and passive play nice together.

One of the biggest reasons why passive tends to beat active comes down to cost. Expense ratios and other fees are hurdles that managers need to clear before they pass on gains to investors. Needless to say, an index fund charging 0.05% is going to have an easier time than an active fund charging 1.2%.

However, if fees are comparable, active management in many sectors – like growth, small- & mid-cap stocks. emerging markets, real estate and fixed income – can perform better than their passive rivals. At the same time, the ability for active managers to pick and choose what assets they own and can fall back on for cash when times get tough limit losses and help produce gains.

The win is that active ETFs have continued to drive down the cost of active management. These days, you can add active ETFs to your portfolio, charging around 0.15%. The fee hurdle is quickly disappearing, allowing investors to truly benefit from active management at the same time.

Enter Envestnet’s New ETFs

When it comes to investment management, retail investors may not be familiar with Envestnet. The firm is a so-called turnkey asset management program or TAMP. The easy definition of a TAMP is an all-in-one investment solution that advisors, banks or financial institutions can use to help manage clients’ money. Think of it as all the background stuff – portals, apps, forms, etc. – needed to run investment management.

Part of that is supporting and offering investment models, with the firm managing roughly $20 billion in-house via these models that are made up of third-party mutual funds, ETFs and its own mutual funds. All in all, Envestnet has run these strategies for 15 years.

The key has been the blending of active and passive management styles within its models. And that’s just what the firm is doing with its new ETFs.

The ActivePassive Core Bond ETF, ActivePassive Intermediate Municipal Bond ETF, ActivePassive International Equity ETF and ActivePassive U.S. Equity ETF use traditional indexing for part of the portfolio but then have an active management sleeve for the other. The funds would use subadvisors for the active portion.

For example, ActivePassive U.S. Equity ETF will place 80% of its assets into stocks that make up the CRSP U.S. Total Market Index. Incidentally, that’s the same percentage the index that Vanguard uses for its popular Vanguard Total Stock Market ETF. The remaining 20% will be spread among stocks, sectors and factors that deviate from the broader index that Envestnet views as being advantageous. In this case, the new ETF holds about 10% of its assets in the Dimensional U.S. Small Cap ETF, which exploits factors. It’s a similar set up for the other three new ETFs.

Of the launch, Envestnet Solutions Co-Chief Investment Officer and Group President, Dana D’Auria said, "As pioneers bringing together active and passive investment styles, our mission has always been to provide investors with a single portfolio that marries the best attributes of both active and passive investing at a low cost.”

"Core & Explore" Made Simple

So, why do this in the first place? Potential outperformance. As we said, active can play significant roles in adding additional returns above an index. This forms the basis of a so-called “core & explore” method of construction. Here, investors and advisors hold the bulk of a portfolio’s assets in broad index funds and allocate a portion of capital towards sectors, regions or factors that an investor feels will do better than the broader market. The idea is to slightly beat the index.

The new Envestnet ETFs essentially do just that. You have a little more “oomph” beyond the index with its active additions. This adds to outperformance.

The best part is that the funds do all the work while advisors and investors sit back and collect the rewards. Rather than own several funds, pay several brokerage commissions and worry about all the hassles that come with buying/selling, they can have one ticker access to a full portfolio. For smaller investors or advisors working with clients just getting started, this allows them to get a full “core & explore” portfolio for very little starting capital.

In the end, it’s about lowering costs. And as we said, cost is the main hurdle for active under performance. With that, Envestnet may have some hits on their hands. Already, the ETFs are having a fast initial asset gathering period, considering they only launched less than two months ago.

What’s more is that Envestnet’s launch could inspire additional ETF issuers to join the active-passive crowd, offering their versions of model-based ETFs. This is good news for everyone.

Here's a summary of the Envestnet ActivePassive ETFs.

The Bottom Line

Active and passive can play nicely together in a portfolio. And Envestnet’s latest launches underscore that fact. Ultimately, the suite of combination management styles will work well to help on the outperformance front thanks to their lower costs – and that’s a huge win-win for investors.