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The ETF space continues to evolve and grow as ETFs are no longer only passive investment vehicles.  Not all ETFs are passive investment vehicles. Active ETFs are gaining popularity among investors and growing at a faster pace than passive or index strategies, says Andrei Bruno, Director, Exchange Traded Funds, at Fidelity Investments Canada. He outlines what advisors ought to know about active ETFs.

Why are active ETFs gaining popularity in your view?

Andrei Bruno: You can broadly put ETFs into three categories: passive, smart beta/factor, and active. Historically, active strategies have been in the realm of the mutual fund space. But now we’re seeing a lot of active strategies come to ETFs, including equities and fixed income. And that’s partly because advisors are now adopting the ETF vehicle. You’re starting to see certain advisors who buy only ETFs now. Twenty years ago, that would’ve been unheard of.

How do active ETFs differ, and what are the potential benefits of active ETFs?

AB: As we know, passive strategies track an index. So you’re getting beta exposure. For example, with an S&P 500 index strategy,
you’re simply getting market exposure. But the primary goal of active strategies is to seek to drive alpha. So, in other words,
active strategies seek to outperform the market.

Active strategies are more tactical. If there’s changing investor sentiment, certain styles are more in favour. It might be a growth market. Tactical active strategies can shift around their positioning. They can go more overweight growth or underweight value, for example.

“ Analyze the investment objectives, what the strategy is, what the style of the portfolio manager is, and what areas they’re investing in — whether that’s asset classes, geographies, or cap sizes.

And there’s typically a lot more research that goes into active strategies. For example, in a broad-based market active equity

ETF, the portfolio manager would look at each and every sector. Since the main goal is to seek to drive alpha, security selection is extremely important.

Are there any emerging trends in active ETFs?

AB: Over the last two or three years, we’ve seen options strategies become more popular. So, whether it’s protective put strategies, equity buffers, or covered call strategies, those have been tremendously popular as of late, and we continue to see assets flow into these areas of the ETF market.

What factors should investors consider when evaluating active ETFs?

AB: When you’re taking a look at an active strategy, analyze the investment objectives, what the strategy is, what the style of the portfolio manager is, and what areas they’re investing in — whether that’s asset classes, geographies, or cap sizes. Take a look under the hood to see what you’re getting, and overlay that with the rest of your portfolio. You may see a portfolio manager who has tremendous returns and say, “Hey, I want to add that manager’s fund to my portfolio.” But it’s also important to ask, “What are my current risks? What are my current exposures in my portfolio right now? Am I adding to those risks? Am I diversifying those risks? Am I ending up too concentrated in a certain geography, a certain asset class, or a certain style tilt?”

How do Fidelity’s equity active ETFs provide potential for outperformance?

AB: At Fidelity Investments Canada, we draw on a vast network of research and investment professionals across the globe. We have investment analysts who cover every aspect of the market, whether that’s specific sectors, asset classes, or geographies. This helps us make in-depth and well-thought-out investment decisions with the goal of seeking to outperform the markets.

Why is it important to have both fixed income and equity active ETFs?

AB: You generally want to be diversified. And your investment horizon will affect the allocation of fixed income versus equity. If you’re getting close to retirement, capital preservation is a lot more important, so, generally, you want to be overweight to shorter duration, high-quality fixed income relative to equities from a risk perspective. Conversely, younger investors have a longer investment horizon, so they may be able to absorb a little more risk and be more tilted toward equity relative to fixed income.

How can advisors discuss active ETFs with clients?

AB: Advisors can consider talking to their clients about the potential for alpha generation relative to index strategies. Whether you’re talking about fixed income or equities, there’s an opportunity for security selection with active ETFs. With index strategies, there’s less wiggle room around what particular securities you can put in that basket. So, the investible space in active ETF management can be a little larger.

For instance, with fixed income active ETFs, portfolio managers can participate in new issues. Index strategies typically can’t. They have to wait until the rebalance period before they can add those new issues into the index, which then gets added into the fund.

Andrei Bruno

Andrei Bruno,
Director, Exchange Traded Funds, at Fidelity Investments Canada

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