MFS Investment Management is credited with introducing the first mutual fund, the Massachusetts Investors Trust, in 2024. The industry’s heyday came in the 1980s and ’90s, when stocks soared and rockstar mutual fund managers like Peter Lynch raked in assets.
The first exchange traded fund came along in 1990 in Canada, with the Toronto 35 Index Participation Units. The U.S. soon followed in 1993 with the SPDR S&P 500 Trust (SPY). The ETF structure then evolved with the advent of active ETFs in 2008, the first one coming out of Bear Stearns, which went under that same year.
And more recently, there’s been a proliferation of active ETF products, as asset managers no longer have to provide transparency in these structures. The SEC’s ETF Rule, which said providers no longer have to apply for exemption relief if they follow certain requirements, also opened the floodgates, said Jennifer Hutchins, co-CIO, Avantax Wealth Management, speaking at the Wealth Management Edge conference this week in Boca Raton, Fla.
Hutchins said that her firm looks for the best active managers, but if those strategies are available in the ETF wrapper, Avantax is going to opt for that every time. She cites ETFs’ accessibility, transparency, liquidity, tax efficiency and low cost.
At the same time, Hutchins has studied active versus passive “persistency,” and found that certain asset classes are more conducive to active management. Large-cap growth and large-cap core equity managers have been challenged to outperform the index over the last 10-15 years. The odds of finding a manager in these segments that can outperform long-term is about 15%. Even Morningstar’s top decile managers aren’t outperforming the benchmark in these segments.
Small-cap equities and emerging markets, however, are areas where active management makes sense, she said. She’s also a big believer of active in real estate and preferred securities.
John Davi, CEO and founder, Astoria Portfolio Advisors, encouraged advisors to use passive strategies in areas that can’t be beat. Real assets, he argued, is one highly nuanced area that could benefit from active management. Regardless of where inflation is at, clients should own a piece of gold or natural resources. These assets provide diversified instruments besides stocks and bonds.
Tyler Rosenlicht, a senior vice president at Cohen & Steers, said infrastructure and natural resources were two examples that illustrate where active management can add value. Infrastructure includes communications, data centers, utilities, satellites, transportation and energy pipelines.
“The commonality for 70% of infrastructure is that these are generally industries that are regulated,” he said. “What I really worry about is regulatory change.”
His infrastructure team, which includes analysts in New York, Europe and Asia, is trying to identify and understand regulatory risks. “That’s not something that I think a passive product is well-suited for.”
Natural resources was the second example he provided where active works better. He pointed to one natural resources ETF, the S&P Global Natural Resources ETF, which he argued doesn’t optimize the risk/return tradeoff. That ETF equal weights the three components of natural resources, including agriculture, metals and mining and energy. And inside the agriculture exposure, it includes things that, he argues, are not highly correlated to agricultural commodities, like timber REITs and paper packaging.
While Avantax will opt for the ETF wrapper, it’s difficult to move legacy mutual fund assets over, due to capital gains, Hutchins said. In an ideal world, the SEC would approve the ETF share class; then the firm could convert those mutual fund assets into the ETF structure.