ETFs were first created as passive investments – vehicles with low fees that tracked a particular index and provided market returns and market risk. In the 30+ years since the first ETF was launched, we have seen an expansion of offerings. Now investors can purchase ETFs that track indices in China, Brazil, really anywhere. However, another popular trend has emerged since 2008. Realizing the popularity of the ETF, the transparency that it provides and its low cost, asset managers started to introduce Smart Beta ETFs that would not merely track an index but try to beat it. This was done by overlaying rules or factors on top of indices. Soon after the ETF market fragmented further with new ETFs tilting towards Quality companies (based on certain fundamental metrics), Dividend Payers or Low Volatility.
For the most part, these ETFs have been mechanically driven – computers running models and executing changes to the ETF portfolios as the models change. What has yet to really be explored in the ETF space is truly actively managed strategies within the ETF vehicle – portfolios that are not run by models but by humans, the way Mutual Funds have typically been managed. The shortcomings of a model are that they are very rigid and can be slow to react. As an example, a Smart Beta ETF that reviews and rebalances its holdings quarterly might hold a name whose fundamentals have deteriorated for longer than an active manager – much to the detriment of the investor. As they wait to feed new information into their model, the active manager has been able to assess an issue in real time and adjust a portfolio accordingly. These types of situations are particularly damaging in Black Swan type events. For example, the Equifax data breach or the Emissions scandal at Volkswagen. Often the tactical nature of active management can provide better returns and sounder risk management, significantly outweighing the potential savings of picking a rules-based strategy.
There is a risk of loss inherent in any investment; past performance is not indicative of future results. Prospective and existing investors in Bristol Gate’s pooled funds or ETF funds should refer to the fund’s offering documents which outline the risk factors associated with a decision to invest. Separately managed account clients should refer to disclosure documents provided which outline risks of investing. Pursuant to SEC regulations, a description of risks associated with Bristol Gate’s strategies is also contained in Bristol Gate’s Form ADV Part 2A located at www.bristolgate.com/regulatory-documents.
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