Some passive ETFs are more active than active ETFs
Active ETFs are grabbing the headlines, but sophisticated indexes can make bigger portfolio bets—and add more genuinely different exposure—than some funds labelled active.
I’m not sure about you, but when I have spare time I like to construct hypothetical ETF portfolios, starting with broad-based index funds. Then, I make it my goal to increase exposure to a sector, space or theme without increasing exposure to the area’s biggest names.
Inspired by Elston Consulting portfolio strategist Andrea Acimovic’s recent comment that owning a global ETF, an S&P 500 ETF, a technology ETF, an AI ETF and a semiconductor ETF might just tell the world that “you really like Nvidia,” I set out to do this with AI.
We’ll save the details for another day, but almost nothing I did meaningfully shifted the composition away from not only Nvidia, but also names such as Microsoft and Apple. If the ETF has tech or AI on the label, chances are you’re getting more the big three and their close friends Alphabet, Amazon and Micron.
It wasn’t until I added the Global X Robotics & Artificial Intelligence ETF (BOTZ) that I increased my AI exposure without piling into all of the usual suspects. Granted, I got more NVDA in my hypothetical portfolio, but Nvidia is the only member of the dominant US tech ensemble that shows up in BOTZ’s top 10. BOTZ can double down on AI, and still push a portfolio into genuinely fresh areas, by adding companies such as Fanuc, Keyence and ABB.
This isn’t a commercial for BOTZ. But it illustrates something that gets overlooked in the excitement surrounding active ETFs: an index tracker can have a more consequential impact on a portfolio than a fund labelled active. The US BOTZ tracks an Indxx thematic index; the European UCITS version follows its v2 counterpart.
Companies such as Indxx turn investment ideas into rules, determining which companies qualify for an index, how much weight they receive and when the index rebalances. Those are investment decisions that happen before the ETF ever begins tracking.
This is one reason why Morningstar principal Kenneth Lamont argues that the active-passive divide is less binary than the labels suggest.
“Rather than treating active and passive as two distinct categories, it is more useful to think of them as a continuum,” Lamont says.
At one end, he says, sit broad market-cap-weighted index funds designed to mirror the market. At the other are high-conviction stock pickers making large discretionary bets. In between sits a wide range of thematic, factor, quantitative and systematic strategies.
“The investment decisions are still active in nature, they have simply been codified into an index methodology,” Lamont says. “Whether a fund is labelled active or passive often tells you more about how the strategy is delivered than how active the underlying investment approach actually is.”
Global X’s Head of Product Research & Development, Pedro Palandrani, concurs: “Passive describes how a strategy is implemented, not how it was designed.”
In BOTZ’s case, that design moves beyond the typical AI tech names and into what Palandrani calls the “physical layer of automation”, sensors, servo-motors, machine vision systems and industrial robots, particularly in Japan and Europe. “That is diversification of the AI thesis, not repetition of it,” he says.
Palandrani argues that the attention given to active ETFs is overshadowing innovation in index methodology, from revenue-based screening to natural-language processing that identifies thematic exposure in company filings before it appears in traditional sector classifications.
“That work rarely gets called innovation because it wears the passive label, but it should,” he argues.
This is one of the aspects of the seemingly endless ETF smorgasbord that’s most fascinating. While a rules-based index can’t respond to events as quickly as an active management team, ETFs that follow actively constructed, highly sophisticated bespoke indexes shouldn’t be treated as interchangeable with relatively boring passive trackers.
Ultimately, the lesson for investors is to always look beyond the label—whether it’s a fancy ticker, slick marketing or the passive/active designation—and ask: What does this ETF actually add to my portfolio?