When it comes to building a portfolio, investors have to make a big decision. And that is whether to use passive-/index-based strategies or to go with active management. There’s plenty of debate on what style is best and numerous funds that cover both styles of investment management.
However, investors may not need to choose.
That’s because a new fund filing from asset manager Envestnet potentially bridges the gap between active and passive ETFs. If the products prove successful, investors may not be forced to choose between the two styles, and instead gain the most benefits from both index investing and human involvement.
See our Active ETFs Channel to learn more about this investment vehicle and its suitability for your portfolio.
The Filing
As a retail investor, you may not have heard of Envestnet – but there’s a good chance your advisor has. The firm runs a so-called turnkey asset management program (or TAMP). Basically, a TAMP is an all-in-one investment solution that advisors or financial institutions can use to help manage clients’ money. TAMPs have grown in popularity as they focus on data integration, asset management solutions, apps and cloud computing to keep all accounts in check and reduce advisor workload. Envestnet happens to run one of the more popular independent TAMPs around.
With that, the firm is making a big splash in the world of direct investment management.
The firm recently filed with the SEC to launch its first ETFs. What’s interesting about the filing is that Envestnet is seeking to blend both active and passive strategies into one fund. Its four new ETFs – ActivePassive Core Bond ETF (APCB), ActivePassive Intermediate Municipal Bond ETF (APMU), ActivePassive International Equity ETF (APIE) and ActivePassive U.S. Equity ETF (APUE) – -will 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.
While the filings were short on concrete details, Envestnet would determine the active-passive investment mix. Using their proprietary research, the firm would look at the likelihood of active managers outperforming or underperforming, histories of outperformance, and academic research on factor investing to determine how much money a sub advisor would get. Overtime, the active-passive split would move based on market conditions and outperformance potential.
For example, the ActivePassive U.S. Equity ETF could have 80% of its portfolio in the S&P 500 Index and another 20% in a U.S. value manager’s funds, if the ETF managers feel that “value” can outperform.
A New Realm of Core & Explore
The new ETFs are potentially groundbreaking in that there aren’t many funds that straddle the passive/active line. Aside from a couple target-date mutual fund suites, most investment mandates of funds are one or the other; investors either buy a fully active ETF or a passive index hugger. And while there are some active ETFs that use passive ETFs as their holdings, they are still actively managed for a strategy. For example, the First Trust Dorsey Wright Focus 5 ETF (FV) buys and sells passive ETFs based on a momentum strategy.
What the new Envestnet ETFs are seeking to do is build a “core & explore” portfolio.
Investors and advisors have been using the core & explore method to juice returns and be better than solely indexing for years. The basis for the strategy is that a portfolio will hold the bulk of its 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 combination of the broad indexed strategy and the active placement into sectors, etc., will provide a better return. Typically, investors would have to buy both a broad index ETF and potentially indexed sector fund, individual stocks or another active fund themselves.
With the new Envestnet ETFs, investors and advisors can solve the headache of conducting a core & explore portfolio. In theory, the ETF would do all the work. 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, this could be a godsend. Allocating a small balance to a single fund that does it all can allow them to have a full portfolio. There’s no requirement to “sacrifice” simply because they don’t have the assets. For larger investors, the new ETFs could reduce costs and managerial overhead.
Start of a Big Trend
The new filings from Envestnet could bring forth a new variety of ETF and spur more managers to act in a similar way. Managers like BlackRock or Fidelity, with their large passive offerings and bench strength in active management, have the capabilities of launching similar active/passive ETFs. And with many fund pundits predicting that the Envestnet ETFs shouldn’t face any hurdles to clear with the SEC to launch, similar funds will almost certainly be on the horizon.
For investors, the filings could signal the growth of active/passive ETFs and a boom in new one-stop-shop solutions for portfolios.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.