Article first published on ASX 7 February 2022.
Active ETFs have a role in building diversified portfolios at a low cost.
Exchange Traded Funds (ETFs) are often associated with passive investing but increasingly, investors are using them to actively manage their portfolios.
ETFs are a collection of investments within a fund that you can buy or sell on ASX. Like individual stocks, ETF shares are traded at prices that change based on the price of the assets each ETF holds. ETFs can give you access to a wide range of markets and help you diversify your portfolio in a low-cost way.
When investing in ETFs, it’s important to consider different asset classes, such as shares, fixed income, property and cash, so you can get the right balance of risk and return for your situation.
Breaking down your portfolio into asset classes allows you to set target allocations for each class. When asset classes rise or fall you can easily rebalance your portfolio according to your original allocations.
Investing across different asset classes allows for diversification, which in turn reduces risk and can allow you to lock in profits from the asset classes that have done well while topping up asset classes when they are potentially cheaper.
Managing risk
In finance, risk is the possibility that an investment doesn’t deliver the return you expect or falls in value.
Making active investment decisions involves predicting the future, which naturally increases your risk – your forecast may be right, but it also may turn out to be wrong.
Using diversified ETFs to execute your own active strategy reduces the risk associated with buying individual securities. Some companies will weather a downturn better than others so holding a basket of shares reduces the chance that you’ll be holding the only one that goes under.
The longer you’re planning on keeping your investment, the easier it generally is to ride out negative returns.
On average, the stock market usually experiences one negative year in every five years. The good news is that markets tend to go up over the long -term.
Active vs passive ETFs
(Editor’s note: Like any investment product, ETFs also have risks . Consider taking the ASX ETFs course to understand the features, benefits and risks of active ETFs before investing. The online course is free and convenient to complete.)
Over the past few years, several active ETFs have been listed on ASX. Rather than tracking a securities index such as the S&P 500 (which represents the largest 500 securities on the New York Stock Exchange) as passive ETFs do, active ETFs include securities chosen by a portfolio manager, based on research.
The key difference between actively trading passive ETFs and trading active ETFs is that with passive ETFs, it’s you as the investor who makes the decisions on market timing and asset allocation, for example, while professional managers make those types of decisions within the active ETFs.
If you want to take the lead on actively managing your portfolio, you can use either passive or active ETFs to do it.
(Editor’s note: Do not read the following ideas as ETF recommendations. Do further research of your own or talk to a licensed financial adviser before acting on themes in this article).
For example, if you believe global equities will outperform Australian equities, you could invest in the Vanguard MSCI Index International Shares (Hedged) ETF (ASX: VGAD), a passive ETF that has over 1,500 stocks from 20 developed-market economies.
An investment in international equities can complement your Australian stock portfolio and allow you to gain greater exposure to industries such as pharmaceuticals that are not heavily represented on ASX.
You can also tilt your portfolio towards certain sectors using passive ETFs, as mentioned earlier. For property exposure, investors could use the SPDR Dow Jones Global Real Estate AUD (ASX: DJRE), which contains 218 global real estate stocks across 15 economies.
For infrastructure, investors could consider the Vanguard Global Infrastructure Index ETF (ASX: VBLD), which has 140 global infrastructure stocks, including transportation, energy and telecommunications.
A wide range of actively managed ETFs is also available, offering exposure to highly specific themes and sectors such as responsible investment, clean energy, biotech, cloud computing or artificial intelligence, to name just a few.
Keeping costs low
Active trading strategies may incur higher transaction costs than passive strategies where portfolio turnover is lower, so it’s essential to minimise costs.
ETFs charge a fee every year, regardless of how your investment performs. If you select your own stocks, you don’t pay ongoing fees. Some investors choose to invest in a combination of both to keep costs low.
The diversity of ETFs available simplifies trading and enables you to build portfolios that capture the market exposure you are after. With the numerous ETFs available to investors, selecting which ETF to invest in can take time.
You can use Bell Direct’s ETF comparison tool to compare the features of all ETFs listed on ASX. You can filter by asset class, sector, provider and fees, as well as look at price information, fact sheets and performance.
Happy trading!