Portfolio Construction
Portfolio makeover: Using active ETFs to reduce risk, save advisors time
Greg Smith
Portfolio Consultant
Brian Robinson

While the “Magnificent Seven” stocks (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla) are getting all the headlines, they are also causing some advisors to wonder if the passive equity allocations in their portfolios are too concentrated.

That concentration issue was one of the main reasons that Indianapolis-based RIA Brian Robinson contacted Capital Group’s Portfolio Consulting and Analytics team to explore custom portfolios built with active exchange-traded funds (ETFs).

“That’s one of the big concerns I had,” Robinson says. “When seven stocks are pretty much driving the entire index, I thought, ‘If you get one or two of those to turn down, is that going to take the entire market?’ But it’s also seven companies that I don’t think you can ignore. The nice thing about active ETF management is that it allows the fund managers to look at those companies individually.”

Greg Smith, portfolio consultant on the Capital Group team, agrees. “Many advisors like passive ETFs because they offer low costs, tax efficiency and transparency,” he says. “At the same time, heavy concentration in the Magnificent Seven stocks has raised questions about potential risks in passive equity ETFs.”

Managing concentration risk is among several factors behind growing interest in active ETFs. “Interest in active ETFs is rising across the industry,” says Smith. While active ETFs represented only 6% of U.S. ETF assets, they accounted for 22% of all ETF inflows in 2023. “That’s a really powerful trend to watch, especially for advisors who are not currently using active ETFs.”

Rising flows into active ETFs

The first chart is labeled “Total ETF flows in 2022 versus 2023” It consists of two vertical bars showing the total flows into both active and passive ETFs in 2022 and then in 2023. In 2022, the chart shows that 505 billion dollars, or 85 percent of ETF flows, went to passive ETFs.  Another 90 billion dollars of flow went into active ETFs, which is 15 percent of all ETF flows. The chart shows that in 2023, 463 billion dollars, or 78 percent of ETF flows, went to passive ETFs. Another 129 billion dollars went into active ETFs, which is 22 percent of all ETF flows. The chart notes that flows into active ETFs increase by 39 billion dollars from 2022 to 2023.The chart relies on assets and flows date from Morningstar Direct, as of 12/31/23.

Source: Assets & Flows from Morningstar Direct, ETFs only, as of 12/31/23.

 Flexibility to focus on long-term goals

Robinson has always encouraged his clients to focus on long-term financial goals rather than short-term performance. In fact, the name of his firm — Snowbird Financial — is a reference to a common financial goal in colder American climates: to build the financial means to spend part of the year as a “snowbird” in Florida or other warm climates. 

“I don’t have a lot of clients who focus on, ‘How well did we do against the S&P 500?,’” Robinson says. “I try to focus on, ‘How much closer are we to reaching your goal? Are we on track? Do we need to save additional funds toward your retirement? Or do things look exactly as they should?’”

Working with Robinson, Capital Group’s Smith helped construct three objective-based custom portfolios using the same objectives used in the American Funds model portfolios. Like the American Funds models, these custom portfolios aim for growth, moderate growth and income, and conservative income for retirement. 

Importantly, the various ETFs that make up each custom portfolio are not tied to indexes or a “style-pure” approach, which gives portfolio managers the flexibility to adjust to changing market conditions while staying focused on long-term goals. 

Focusing on long term-goals: Portfolio positioning for a range of objectives

The second chart is labeled “Portfolio positioning for a range of objectives.” It shows, from left to right, three different models – a growth model, a moderate growth and income model, and a conservative income/retirement model. Within each model, the graphic shows how those models are allocated to different asset classes. The first model, growth, is allocated as follows: 75.6 percent to U.S. equities 20.8 percent to non-U.S. equities and 3.6 percent to cash and cash equivalents. The second model, moderate growth and income, is allocated as follows: 46.9 percent to U.S. equities, 29.7 percent to fixed income, 18.5 percent to non-U.S. equities and 4.9 percent to cash and cash equivalents. The third model, conservative income/retirement, is allocated as follows: 56.9 percent to fixed income, 26.8 percent to U.S. equities, 10.9 percent to non-U.S. equities and 5.4 percent to cash and cash equivalents.

Source: Capital Group. Allocations are examples of what an investor with the identified investment objective might consider and are for illustrative purposes only. 

A closer look at the Moderate Growth and Income custom portfolio using active ETFs brings the flexibility into clear focus. Within the various active ETFs, there is flexibility in style (growth and value), region (U.S. versus non-U.S.) and asset class. In fact, 25% of the Moderate Growth and Income custom portfolio is devoted to a multi-asset fund, in which portfolio managers can adjust the mix between equities and fixed income.

Active ETFs build flexibility into custom portfolios

The third chart is labeled “Allocation weights for moderate growth and income custom portfolio using active ETFs” It shows a portfolio that is allocated as follows: 45 percent to equity ETFs. The breakdown within the equity portion is 20% dividend growth, 15% global dividends, 5% core equity and 5% global growth. 30 percent to fixed income ETFs. The breakdown within the fixed income is 10% core bonds, 10% core plus and 10% multi-sector. 25 percent to multi-asset ETFs. The entire portion is in a balanced fund. The source for this custom portfolio information is Capital Group.

Source: Capital Group

Smith notes that active ETFs build flexibility into the custom portfolio, similar to the approach Capital Group uses in its American Funds models. “As more investors turn to ETFs, we think it’s important to address a wide range of investor objectives,” Smith says. “Active building blocks can be used within portfolios to flexibly respond to changing market conditions, which can help advisors reallocate their time toward other client objectives.” 

Model portfolios provide time savings for advisors

As a sole practitioner, a constant challenge for Robinson is managing his own time. After he moved on from his initial approach of personally building every aspect of his client portfolios, he began using models to combine various ETFs. His experience with model portfolios built entirely from passive ETFs, however, was not optimal. He found that adjustments to the fund mix within those models were frequent and, for him, very time-consuming. 

“The biggest thing for me is not having to go in and make those minor adjustments to overall portfolios that can take two days of my time. With the active ETFs, I know those adjustments are happening inside of that wrapper. That’s a huge time-saver.” 

Robinson was previously making frequent adjustments to ETF selection based on market and sector changes. “But swapping energy sector ETFs for financial sector ETFs in response to market conditions, for example, or shifting from corporates to U.S. government bonds can take several days of rebalancing across many portfolios just for one change,” says Robinson. Instead, Robinson finds it helpful to step back from short-term asset allocation shifts to assess whether the portfolios are tracking toward his clients’ goals.

Spending less time on portfolio construction — and less time tracking market fluctuations — allows Robinson to spend more time face-to-face with his clients, focusing on their futures.

“I have an old-school client base, meaning they like to see me in person, they like to sit down and talk through some of their goals and challenges,” Robinson says. “This gives me more of an opportunity to be in front of clients. That’s the most meaningful part of the job for me: being in front of clients and learning what they’re trying to accomplish.”

Want to take a more flexible, active approach in your portfolios?

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Greg Smith is a senior portfolio consultant at Capital Group, home of American Funds. He has 18 years of industry experience and has been with Capital Group for five years. Prior to joining Capital, Greg worked in sales at First Trust Portfolios and as a financial advisor at U.S. Bancorp Investments. He holds a bachelor's degree in history and education from Taylor University. He also holds the CERTIFIED FINANCIAL PLANNER™ & Certified Investment Management Analyst® designation. Greg is based in Indianapolis.

Brian Robinson, advisor and founder of Snowbird Financial LLC, graduated from the Indiana University Kelley School of Business in 2003. He began his financial services career in 2005 working as a financial advisor for Ameriprise. In 2007, he joined Charles Schwab and worked in various positions, most notably as an associate portfolio consultant in Schwab Private Client. He founded Snowbird Financial in 2012.

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