ETF Edge - The continuing evolution of “active” management 7/7/25

Episode Date: July 7, 2025

With markets seeing unusually high levels of volatility across the board this summer, the “active management” corner of the ETF industry has had to continuously increase specialization. But does that focus carry a risk of becoming too narrow too soon?          Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ. Let's rethink possibility. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange-traded funds, you're in the right place. Every week, we're bringing you compelling interviews, thoughtful market analysis, and breaking down what it all means for investors.

I'm your host, Dominic Chu. Now, this summer has been anything but sleepy, with signs of more volatility in both equities and fixed income as we head into the second half of the year. So here's my conversation with Roger Hallam, the global head of rates at Vanguard, alongside Jay Jacobs, U.S. head of equity ETFs at BlackRock. Now, Roger Vanguard has long been, and I mean long been known, for passive index-based products. But you are very much getting more active, if you will, and actively managed ETFs, especially in bonds, an area of the market previously known for its relative stability.

So maybe take us through, first of all, Roger, why Vanguard is getting more into active ETFs versus your decades' worth of passive indexing DNA, and what exactly you hope to achieve by doing so more so in the bond market? Sure. I think investors are increasingly expressing a preference for the ETF vehicle and we are looking to serve investors at where they want to be. And so we have a very successful range of active mutual funds and we are looking to expand our product offering into the ETF wrapper. We've now launched eight active fixed income ETFs. We're about to launch our bank.

our government securities, ETF, which will be our first focus on the government space. But really, it's a case of expanding our offering to meet client demand. This client demand that's out there, ETFs and the demand for them, is no secret. It's been decades in the making right now. What exactly is, you know, I don't want to get, I don't want you to give the secret sauce away, Roger, with regard to what you're doing. But when it comes to somebody who is the global head of rates at Vanguard, Can you take us through what the thinking or construct is by which you go and actively manage a bond fund?

In other words, when do you start overweighting, say, treasuries versus mortgage-backed securities, or when do you flip around again? What are the types of things you are looking for to dynamically manage a bond portfolio of these different sizes? Sure. Our active philosophy is we want to use high information ratio strategies to deliver repeatable returns for clients. And we do that in a very diligent risk-controlled framework. So when we think about dynamic allocation, say, between government securities and mortgage-backed securities, we're looking for when those opportunities are asymmetrically skewed towards positive returns.

And at that point, we will ask our sector teams to deploy risk, within their sector, but not just from a beta perspective. We're very focused on delivering bottom-up security selection to ensure that our alpha generation is as high information as it can be so that we deliver repeatable returns for our investors over the investment cycle. All right, Jay, this is maybe something we're talking about a little bit more now with regard to the actively managed bond side of things, more so. They've been around for years. Active management when it comes to equity ETFs have been around or at the forefront, I would think relatively longer than they have been fixed income. So when it comes to actively managed equity ETFs, what do you think are some of the similarities and differences between how those products are treated on the active equity side versus the active fixed income side?

Well, the world has shifted a lot in the last few years. I think, you know, looking at a high level, you see more volatility, you see more dispersion across different. sectors, different parts of the equity markets. And frankly, if you look at the last 10 years, just having beta exposure to the markets was a tremendous exposure for your portfolio, but that might not continue over the next 10 years. So we're seeing a renewed interest in active strategies. I would really decompose active into three buckets, though, when we're talking about the equity

space. There's alpha seeking active, which is really portfolio managers trying to beat a specific benchmark like the S&P 500. There's outcome-oriented active ETFs, which are trying to deliver. a specific outcome, whether that's higher income or protection against the downside. And then finally, there's more exposure active. These are corners of the market that are maybe just more difficult to index. So when you look across that active equity landscape, there's a tremendous breadth of products and there's a really renewed interest in getting active strategies into portfolios

because of that volatility to dispersion and potential risk of lower returns going forward. Jay, how do you feel as though investors, whether they be retail folks like me or others around there or registered investment advisors. How do you feel as though that kind of use of these active equity ETFs has evolved over time? And what exactly do you think the sophistication level is for, say, a retail investor to use actively managed ETFs as part of their portfolio? No, one of the great things about ETFs, which has been the case since day one, is that it democratizes access to so many different strategies and asset classes. So previously strategies that maybe were harder to access or there was investment minimums or the tax efficiency meant they could only be used by institutions that were tax advantage. That has largely gone away with active ETFs. We see them being used by end investors, by financial advisors, and by institutions really across the board.

When you look at the reasons why, though, we talked to a little bit. little bit about the dispersion, but other reasons, the tax efficiency of the ETF structure has been huge. We see that active equity ETFs are much less likely to pay out a capital gain than actively managed mutual funds and similar categories. We see that the accessibility is a major accelerant for active ETFs. We do see end investors buying active ETFs because it's generally easier for them to access them than active mutual funds. And then finally, a major driver has been the growth of the model space. You've seen just hundreds of billions of dollars pouring into ETF models that are scalable, repeatable, cost efficient, and increasingly those models are adding active strategies to introduce

new sources of alpha for their clients. So there's a lot of tailwinds between end investors, tax efficiency and models all really kind of leading up to this adoption of active ETFs. Roger, how much in your mind of the demand for these ETF products on the active side of things has been more towards to what Jay alluded to, the alpha seeking or outperformance seeking side of things, versus investors putting their faith in an active manager to help them kind of guard against some of the volatility and downside that we are seeing more so these days

over the course of the last six months to a year than perhaps we've seen over the course of the last 10 or 15 years. I think it depends on exactly what ETF there, allocating too. I think about certainly our active ETF range, we're focused on enhancing returns for investors around their benchmark allocation. So we're seeking to outperform our designated benchmark and deliver those enhanced returns for our investors. And of course the important point here is we're focused on delivering positive net of fees returns for investors with low expense ratio so that investors can keep the majority of their return while, well, well,

while minimizing costs. So I think it depends on the product, but certainly for Vanguard, we're focused on delivering high-quality information ratio alpha that contributes towards investors' success. Roger, can I follow up on that with one other point? The fixed-income market has been a huge focus in terms of volatility over the course of the more medium to, you know, recent term over the last couple of years. We're coming out of an environment where we've been in this kind of zero-interest rate, near zero interest rate policy since the great financial crisis. There seems to be a normalization play for macro forces in the market right now, including the Federal Reserve, about trying to see whether or not we can get to some kind of more neutral interest rate policy that kind of fits

the macroeconomic narrative. This is a paradigm that has not existed prior to over the last five or six years because we've never engaged in this market in the way that's the way that that central banks have since the great financial crisis. How difficult is it for a bond manager, an active manager with regard to fixed income in navigating this kind of normalization, vis-a-vis inflation, vis-a-vis economic growth or the volatility that lies ahead? Yeah. Well, first thing I think it's a great time to be strategically allocating to fixed income. As you said, we had a long period of very low interest rates. We look at the prevailing interest rates. Today, we think it's a very attractive time for investors to start strategically allocating

towards fixed income. And then when we think about some of the volatility challenges, some of the policy challenges we've seen from the central bank and indeed government policy, from an active manager, that is ideal. We want volatility to be able to make decisions, be able to evaluate the investment opportunities in front of us. And obviously, we're looking for those opportunities which we think we can, we can, we can, we have insight to and that offer asymmetrically positive returns for our clients.

And that's where we dynamically allocate our risk towards those opportunities where we are confident we can enhance returns for investors. How difficult is it, Roger, to do that in an environment where you don't really understand what the movement out of Washington, D.C. will be with regard to not just the Federal Reserve and its head, Jerome Powell, but also to what the anticipated fiscal policy would be. Yeah, I mean, obviously there has been a lot of volatility. You're absolutely right. But we're focused on the medium term.

We're not focused on week-to-week volatility, and that's certainly what we've seen, a lot of policies announced and then subsequently rolled back or extended deadlines. We're focused on those medium-term investment outcomes for clients where we think we have the greatest insight and where we can position portfolios strategically to benefit our end investors. Jay, have you seen anything with regard to the flows that you watch over at Black Rock with regard to where investors see the opportunities and or the heat, so to speak, in the coming

weeks and months? So is there anything to glean from where people are positioning to say, hey, maybe these will be the trends going forward because the markets and investors are already starting to try to lean that way? Absolutely. Absolutely, you know, two areas that come to mind. You know, first is we've seen a lot of flows going into rotation ETFs. These are actively managed ETFs like DYNF or Throw, T-H-R-O,

that are able to very rapidly redeploy capital in the parts of the markets that our systematic team see as being the most interesting. So in D-Y-N-F, it's really about factor rotation, which factors are most likely to benefit in this current macro environment. Meanwhile, in Thoreau, it's really about what themes are most likely to work in this macro environment. So looking at things like belt tightening amongst consumers where if there's a little bit more economic shakiness,

how our investors got to reduce their spend to be a little bit more cautious in light of what's happening in the macro economy. Or when you look at businesses and how business spending is shifting, what kind of CAPX businesses are going to do better around artificial intelligence. So dynamic strategies have been huge. They're very active. They're tactical. And they're also very tax efficient within the active ETF structure. On the other side of the equation, you know, on more of the fundamental business, we're seeing a tremendous. amount of interest in artificial intelligence, really looking across the value chain at a fund like BAI, where investors see the long-term opportunity, they see the trillions of dollars

that are likely to be generated from this economic opportunity, but they realize that just looking at mega-cap tech names is not a very nuanced way of applying artificial intelligence. You have to look across the value chain from data owners to semiconductors to AI platform developers, even to AI applications, you know, companies that are introducing AI into their product, today. So taking an active lens to such a massive theme like artificial intelligence has been very popular with our fund, BAI. Jay, the passive indexing ETF world is leaps and bounds, orders of magnitude bigger than the active ETF mold right now that you are referring to. Do you ever see an environment where you will start to see a little bit more parity, if you will?

I mean, I don't know how long it will take, but will more people, start to lean out of the passive indexing type instruments and more into active ones. And what exactly will it take for them to keep that transition momentum going to get away from indexing and more into actively managed funds? Well, in the ETF space in the United States, we've seen active growing faster than index. Now, we see tremendous structural trends behind both. We still see a lot of assets moving into index-based strategies where investors are looking for low-cost, core, diversified tax-efficient ways.

of building the core of their portfolio. But increasingly, we're seeing ETFs be the vehicle of choice for active exposures, for people that want to introduce alpha or outcomes or active exposures into their portfolio. So both are growing very nicely alongside each other. As I was mentioning, this environment with volatility, with dispersion, with more uncertainty, maybe forward returns that might not be as good as the last decade,

really lends itself to active. So I think we're seeing a comeback inactive right now, but it's really a comeback that's happening in the ETF structure because so many investors are looking for the tax efficiency of ETS and looking for the accessibility and scalability of ETS as well. And Roger, as we talk about the use of some of these active products, especially when it comes to fixed income, how exactly would you envision investors of all types, whether retail or institutional, using some of these active fixed income products?

Do they build around core passive positions and just use allocations to these types of instruments to achieve some of that outperformance? Or do you envision a time when people can just place a core holding in an actively managed fixed income product in the hopes that they will, again, just continue to beat an index overall? As I mentioned earlier, we think now is the right time to be strategically allocating to fixed income. and we think it's an important ballast for people's portfolios. And I think about the Vanguard Government Securities ETF we're launching this week, VGVT, we think that plays a key role in investors' portfolios.

You think about an investor that has a relatively high allocation to equities, for example, or other risk assets. A government securities ECF acts as a solid buffer to that portfolio. If we were to see less favorable economic outcomes or volatility associated with geopolitical events, typically you see risk assets underperform in those environments. We would believe that an ETF such as the Vanguard Government Security's ETF would be outperforming in that environment. So certainly an opportunity there to act as a balance for portfolios. The alternative might be if an investor with a core bond portfolio, they might want to be upgrading that portfolio

to a little concern that credit spreads could widen. Again, tilting the portfolio a little towards VGVT, for example, would be a way of adding safety and security. securities their core bond portfolio. So I think you can view it very much from a strategic allocation perspective. And before we let you go, Roger, I'll ask both of you a similar type question. For you first, Roger, as the global head of rates, what exactly is the thing that you are most focused on for the second half of the year with regard to how it affects the dynamics in your market? Yeah, I think it's that growth inflation trade-off. The Federal Reserve has stated very much. It's on hold

it's watching to see how that trade-off between its employment mandate and its price stability mandate play out. Now, our outlook for the second half of this year is that growth will slow. We will see the labor market continue to gradually cool, and in that environment, the Fed will have a choice between prioritizing the growth and employment side of its mandate or the inflation side. Now, we do see inflation rising over the coming months. We think heading towards sort of two and three-quarter percent on a core PCE basis by year-end.

But we think the Fed will ultimately prioritize what we think will be a continued cooling in the labor market and want to provide some insurance. So we think the Fed will ease a couple of times towards the end of this year. We think that would provide a tail win for bond, a tail win for fixed income performance. And so we're confident in the outlook for fixed income. And we think they say that clients should be allocating to fixed income right now. All right. And Jay, similar question for you, except tilted towards the equity side of things, your area of expertise.

What exactly is the thing that you are watching for the most in the second half of the year? Is that same macro narrative relevant to equity ETFs as it is to Rogers Bond World? Well, I think we're going to see a bit of a barbell here. On one end of the spectrum, I think we're still going to see a lot of money that's been in cash for a long time. $7 trillion in money market funds start to inch their way back into the equity markets, but probably doing so in a really risk-minded way, using things like buffer ETFs, which can protect against the downside and still give a measure of upside performance. Our fund Max J recently reset, giving a cap of up to 7% exposure to the SMP over the next year.

I think a tool like that is going to be very much in vogue for investors looking to get back into the markets. Now, at the other end of the spectrum, I think people are going to be playing offense looking at powerful macro themes. We mentioned AI, but I also think infrastructure is going to be a very key area to look at, as we continue to see geopolitics and fragmentation around the world impact markets. I think people are going to be looking at really power. macro trends like the growth of infrastructure in the United States as a way to, you know, place their bets in the equity markets where they have higher conviction. Now it's time to round out the conversation with some thoughtful analysis and perspective

to help you better understand ETFs with our Markets 102 portion of the podcast. Jay Jacobs, U.S. head of equity ETFs at BlackRock, continues with us now. Jay, it was a fascinating conversation, and I want to focus a little bit on one of the things that you alluded to earlier in the podcast and to close things out. And that is the use of active ETFs, but then specifically this kind of new hot product that's being put out there across numerous issuers with regard to buffer products. And maybe you could take us through a little bit about what these buffer ETFs are and how exactly they are being used.

Absolutely. So buffer ETFs have been one of the fast. this growing areas of the ETF market over the last several years. You know, actually, if you expand the tend to include both buffer and buy-right income strategies, they've grown from about $5 billion six years ago to over $200 billion today. We still think it could be over $600 billion by 2030. So this category is growing very, very quickly. At its essence, these are strategies that are using options to give more defined payouts to investors. So if you think about just investing in the market, buying IVV,

to get exposure to the S&P 500. We see years where the SMP does incredibly well. It's rallied 20% last year. We've seen years where the S&P does very poorly. You can see it sell off double digits in a given year. Buffer strategies are trying to give a more definite type of return payoff to largely the S&P 500. So if you look at a fund like Max J, what it is doing

is over a one year period, if you buy it at the beginning of that inception period, you have full protection against the downside. meaning you will not experience a downturn if you own it for an entire one-year period. And the way that that is funded is by giving up some of the upside. Now when this fund reset back on July 1st of this year, that upside was capped at just over 7%. So you can now see that your range of outcomes,

if you're just buying the S&P 500, maybe up double digits, down double digits. But with Max J, your range of outcomes is actually flat or up to 7% given what happens in the S&P 500 over the next one year period. That is a much narrower range of outcomes for investors, and that type of definition is really valued by investors that are worried about market risk, that have been keeping cash on the sidelines, that are really kind of looking for more specific types of outcomes on the markets rather than just tracking the S&P 500. To me, though, Jay, that seems as though you are targeting, I wouldn't call it a niche part

of the market, but there is a total addressable market for that kind of a product. that maybe for the time being isn't as expansive. And the only reason why I say that is because if you are in a situation where you've guarded against all the downside risk, but you've given away something, right, to pay for that, and that's any upside, say hypothetically over the 7% reference mark that you said, aren't there those people who might feel a little bit strange about saying, hey, you know, what if I don't participate in the upside? What exactly is the target risk demo for those people who would want to use a buffer

ETF type product? Sure. I mean, there's a few different categories of people that I think, you know, would really be kind of leaning into this type of product. You know, one is who's been holding cash on the sidelines for the last couple of years, watching the markets continue to rally despite, you know, all the perceived risk out there and saying, gosh, I wish I got in, but I just don't know if I get in today if I'm going to start to see, you know, the big sell-off, right?

If you were that person in February of this year and you've been waiting to put your money into the markets, you immediately experienced about an 18% sell-off from February to April. So for people that have been sitting on the sidelines that are very risk-adverse, that want to protect against the downside, that's a very clear use case for this type of product. I think secondly, if you look at people who are nearing retirement, these are investors that are really in transition from being in a more equity-oriented portfolio into something that's more fixed-income-oriented. And these types of buffer products really sit in the middle where you get some of that equity experience,

but also some of that principal protection that fixed income offers. So that nearing retirement investor is really in the sweet spot of this type of strategy. And then thirdly, just investors that are looking to build a diversified portfolio could really be adopters of funds like Max J. I say that because a lot of investors used to just build 60, 40 portfolios for diversification. And it worked because largely equities in fixed income, had very low correlations to each other. But what we've seen over the last couple of years is that correlation has risen. So just using asset class diversification as a way to balance your portfolio is no longer working

the way it once did. But introducing strategies like buffer strategies or funds like MaxJ into the mix can really provide an element of diversification that asset class diversification is not providing anymore. So those are three really large categories, Dom, of investors that I think are likely to adopt buffer strategies now and over the next several years. All right, Jay, this is interesting because over the last few months, this debate about the use of buffer products in the ETF market has really taken a lot more attention,

mostly because there's been a big debate about just what the usefulness is and how exactly these things really do become an advantage for the investors out there. I know that there's been a lengthy, even couple of now essays or posts from folks like Cliff Asniss at AQR, advocating against the use of some of these buffer-type products saying that you can achieve some of the same outcomes by just mixing a passive indexing type product and kind of adjusting your cash buffers yourself within them. Maybe, I guess the question for you is, what do you see as some of the kind of case, again, using just traditional strategies and kind of managing cash situations as opposed to kind of paying for or giving up certain upside to pay for the downside insurance for some of these buffer products? I mean, at the end of the day, they're very different strategies, right? Especially in the short term. So maybe if you look over the very long term, you know, kind of a blend of different cash and equity strategies may start to resemble the payoffs of certain buffers, but that's not necessarily the use case here. Buffers are trying to give you a very specific

amount of downside protection over a given timeframe. So as we mentioned, investors that want to get into the markets but are worried about seeing an immediate sell-off, or investors nearing retirement where sensitivity to major drawdowns is going to be very high as you get close to that retirement age and move to more income-oriented portfolio, having a defined amount of risk protection can be very valuable for those investors.

Now, on top of that, you know, a lot of the, you know, some of the research you're referencing out there is looking broadly at the buffer space, we can really only speak to our platform where we focus on quality. This is where we've been focused on, you know, really bringing value to investors with, you know, market leading fees. This is where we've been focused on how do we achieve the best possible payoffs for investors. You know, we've seen instances where we have similar payoffs to other providers, but our caps are one and a half to two percent

higher than other providers because of the scale of BlackRock and our ability to tap into the capital markets in a very efficient way. So we stand fully behind our strategies and the quality they deliver to investors who are looking to get that measure of protection in their portfolios, particularly over the short to medium term. Jay, there's also one final point or a question I want to make out there. You mentioned how you pay for the downside protection because you sell options, right, or you sell some kind of an upside away. You kind of do that to manage around this kind of buffer scenario.

If you look at beyond that, you mention the fee structure. for these buffer type products. What exactly can investors expect with regard to the fees charged to manage these buffer ETFs compared to say other indexed ETF type products? And with that, do you feel as though the fee structure will eventually, and I'm sure it will, compress, but how quickly can this market evolve to where the fees are becoming more and more similar to say some of the index or passive type products? Absolutely. I mean, Max J, our max protection ETF for June, the fees are 50 basis points. That is, you know, market leading in many instances compared to our competitors and other products out there. I think you have to look at, you know, where are we coming from with these types of strategies. First of all, many people can't really do this operationally on their own or they can't do it at scale or it's very expensive for them to do it by trading the options themselves. You know, second, if you look at some other categories where you've seen these types of payoffs like structure, notes, they tend to be in the, you know, well over 1% in their fees that they charge investors.

And then finally, if you look at, you know, other buffer ATFs in the industry, you often see 80, 90 basis points of fees. So we feel very comfortable with 50 basis points, providing tremendous value to investors who are looking for, you know, a fairly nuanced strategy using different options, payoffs to get that exposure and that level of protection and delivering that at scale to investors across our lineup. Jay, we haven't seen a massive, I mean, we've seen drawdowns, We haven't seen a really, really kind of massive drawdown situation since probably the COVID pandemic. Do you feel as though the buffer ETF space gets a lot more attention in the event there is a much larger drawdown? Do you think that's what it'll take to get more people into it?

Or do you feel as though the growth trajectory for buffer ETFs will be modest but okay even without any kind of a massive drawdown happening? Is a drawdown necessary to create the attention needed for buffer ETFs? for ETF products? No, not necessary. I mean, look, we've seen tremendous growth in this space with markets still reaching all-time highs. I think, in fact, it is the fact that markets are near all-time highs that there's a lot of interest in buffer ETFs because you see investors who are looking at the markets, they're looking

at the risk in the macro sense and saying, I kind of like where I am. I like that I've ridden the markets up this far or I like what I'm seeing in the markets, but I just worry there could be a major sell-off in the future. And so that type of scenario has been very positive for buffer ETS. Yes, I'm sure if there's a big selloff, it'll remind people, you know, of risk in portfolios and how to manage risk. But I don't think that's a necessary condition for continued adoption of these strategies. We're seeing adoption amid market all-time highs. It just comes with a lot of investors looking across the macro environment and saying there's risk out there and they need to protect against it.

All right. Jay Jacobs at BlackRock, thank you very much for taking the time to join. us on ETF Edge the podcast. We appreciate it. Thank you, Dom. All right, that does it for ETF Edge the podcast. Thanks very much for listening. Join us again next week or just head over to etfedge.c.cnbc.com. How does InvescoQQQQ rethink possibility?

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