Managed ETF portfolios
Among the draft offer documents filed with SEBI are many fund-of-funds (FoFs) intending to invest in the same family single ETF. For example, silver FoF investing in the same-family silver ETF. Perhaps, there is more potential to use FoF to offer products with a basket of ETFs. Here, we discuss Managed ETF portfolios.
Passive-active-passive
A Managed ETF portfolio involves three participants — you (investor), the portfolio manager who constructs an ETF portfolio and the ETF manager who passively manages the ETF (underlying investment). Suppose a Managed ETF portfolio manager decides to create a portfolio consisting of a Gold ETF, a Nifty ETF and a Mid-cap ETF. This portfolio manager must continually manage the position with the objective of timing the market to generate returns. Note that each ETF — gold, Nifty and Mid-cap — is passively managed by the respective ETF manager. If you were to map the participants to the investment process, you have a passive-active-passive approach — passive (you) — active (Managed ETF portfolio manager) and passive (ETF manager).
Consider two arguments. The objective of the Managed ETF portfolio manager is to generate alpha by continually changing the allocation to style, sector and strategy ETFs. For example, Nifty 50 ETF is a style (size-based) ETF, Nifty Bank ETF is a sector ETF and Nifty100 Low Volatility 30 is a strategy ETF. Suffice it to understand a Managed ETF portfolio is relatively easy to create using style and sector ETFs. It is optimal to passively manage investments in a Managed ETF portfolio. If entry and exit are frequent and not well-timed, the portfolio returns could suffer despite the Managed ETF portfolio manager performing well. It is crucial the portfolio manager considers style and sector universe, including third-party ETFs to pick the ones actively traded.
Conclusion
At a macro level, the Managed ETF portfolio relies on the portfolio manager's ability to select ETFs to invest in. For instance, the manager may decide to invest in a pharma ETF instead of a banking ETF. At a granular level, the Managed ETF portfolio brings to the fore the market timing skills of a portfolio manager. Therefore, alpha returns can come from allocation (proportion of sector and style ETFs) and market timing (when to buy and sell). This product should be kept outside the core portfolio. The Managed ETF portfolio could be structured as an open-end fund (FoF structure).
(The author offers training programmes for individuals to manage their personal investments)
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