Passively managed products are coming out increasingly with active options. And actively managed products rely on increasingly sophisticated sets of passively-derived data sources. With a widening spectrum of combinations between both approaches, and an increased diversity of investment recipes, are two labels still appropriate for the marketplace of today?
Panelists at the 2019 Exchange Traded Forum earlier this week discussed how new technologies and actively selected targets are blending calculations and creativity into a continuum of investment approaches, to the extent that investors should view their portfolios with overlapping lenses and an open mind to benefit from the best of both worlds.
Passive should no longer be pitted against active, and vice versa. There is a place for both, said Michael Keaveney, Head of Investment Management for Morningstar Associates Inc. “Not only do you want both, but if you don’t have already have them in your portfolio, then you should have both.” Keaveney, was joined by panelists Robert DeRochie, Sr. Vice President and Client Portfolio Manager, Fixed Income at First Trust Portfolios and Deborah Fuhr, Managing Partner and Co-founder of ETFGI.
The lines begin to blur
Investors have over the years viewed a mutual fund as active and an ETF as passive, but this perception is changing as many active strategies have launched in the ETF structure while many mutual funds can be replicated in the ETF, notes Paul MacDonald, CIO, and Michael Kovacs, CEO at Harvest Portfolios Group.
Data-driven financial analysis and elements of ‘passive’ management have been creeping into the active frame for decades. Automated, rules-based calculations and assessments are certainly used at least at the lower levels of data collection through financial reporting and research systems used by active managers.
“Active has always tracked indices,” said Keaveney, adding that all but the most granular stock pickers have always used factors. And it’s worth taking into the account the increasing sophistication of tools available to stock-pickers today.
Meanwhile, on the passive end of the management spectrum we find human-led evolutions and expansions of calculations, more sophisticated rules, and active factor selection in products such as strategic beta. “The building blocks of passive strategies today might be passive, but you have an active element in combining underlying ETFs in some cases and certainly when you’re selecting factors for a strategic beta product,” Keaveney said.
Blindsides at both ends
Solely focusing on the active management aspects of a strategies leads to the question of whether a human manager can or will do as he or she says, notes Keaveney.
“What’s the criteria for assessing the skill of a manager? What’s the process?” he asks, pointing out that it comes down to their ability to forecast accurately. The skill is rare, and often priced too high.
On the other hand, solely focusing on a passive play can lead to difficult circumstances where active involvement is necessary. Panelist DeRochie cited an example of GE debt, where passive funds held on to bonds as they dramatically fell in value, while active managers sold.
Panelist Fuhr pointed out the need to also consider how active and passive strategies are integrated within funds. In response to DeRochie’s example of a passive pitfall around GE, she suggested an active, thematic overlay around ESG might have prevented the debt disaster.
How will investors be informed?
As the complexity of active/passive blends increases, the question going forward is how will investors be able to navigate the widening investment management spectrum?
Strategic beta products, for example, are “blurring their status on the active-to-passive continuum,” notes Ben Johnson, Director of Global ETF Research at Morningstar in his latest report on strategic beta exchange-traded products.
Morningstar has taken steps to clarify the widening strategic beta spectrums for investors through refinements in the traditional active and passive buckets, grouping factors from value, to low-beta and equal-weighting into new buckets focused on ‘return’, ‘risk’ and ‘other’, respectively.
“As these strategies become increasingly nuanced, looking to infuse elements of an active manager's thinking into an index, investors' collective due-diligence burden will continue to increase commensurately,” Johnson says.
