Seeking downside protection, investors check actively managed ETFs

With interest rates rising and volatility up in the markets, however, investors may be shifting away from pure indexing toward more active management of investment risk.

“It’s about downside protection,” said Ryan Sullivan, a vice president of global ETF services at Brown Brothers Harriman. Sullivan helps fund companies to design and administer their products.

“There seems to be a growing interest in actively managed equity products in an ETF wrapper,” he said.

Actively managed ETFs, where portfolio managers pick and choose investments like active mutual fund managers instead of simply tracking an index of assets, have been growing rapidly, albeit from a very small base. The lion’s share of assets in the space is in fixed-income funds employing total return or low duration strategies.

“It’s taken time for active management [in ETFs] to gain traction in the market,” said Sullivan. “The segment has continued to set records in terms of growth, but it still represents only 1 percent of the broader market.”

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That may change this year, judging by the results of a recent survey of financial advisors and institutional investors by BBH. The survey found a big increase in interest in the products, particularly in the area of international equity and emerging markets, which attracted $239 billion in fund flows last year, per Morningstar.

To that point, 54 percent of survey respondents said they would use actively managed ETFs in emerging markets, and 45 percent said they would do so in international developed markets.

“I think we may see a spike in demand for actively managed ETFs this year,” Sullivan said.

The explosive growth in so-called smart beta funds also suggests investors are not as comfortable buying the market or segments of it through simple indexing. Assets in smart beta funds surpassed $1 trillion in December and now comprise about one quarter of the entire ETF market.

The funds still passively track an index, but they use a rules-based methodology to screen a universe of securities for desirable factors, such as profitability, high dividends, low volatility or value for equities. In the fixed-income market, popular factors to emphasize include credit quality, yield and duration.

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