Exchange-traded funds have revolutionized portfolio construction. With low costs, broad index exposure, and easy tradability, ETFs have become the de facto way many investors and financial advisors build portfolios. And now the growth of active ETFs has continued to expand on that further.
Now, investors can further diversify their portfolios.
That’s the gist from a new report from Goldman Sachs. The creation of active options ETFs providing downside protection and income potential is a game-changer for portfolio construction. For investors, it’s just another way that ETFs, and increasingly active ETFs, are changing the game.
Active ETF Growth
In a few short years, active ETFs have gone from being a small niche to becoming one of the largest investment vehicles around. The number of active ETFs has grown from a small handful of active products in 2008, when the first active fund launched, to over 1,765 by the end of 2024. The trend has continued this year with several legacy asset managers, such as MFS and Cohen & Steers, finally breaking into the ETF game.
These days, more than $1 trillion of investors’ assets sit in active ETFs.
It’s easy to see why investors have become enamored with active ETFs. Offering all the benefits of passive funds, such as low costs, intraday tradability, and diversification, active ETFs have unique advantages. This includes the potential for additional returns from added alpha generated through human engagement.
Enhanced Diversification
However, active ETFs may provide an additional benefit, and that’s enhanced diversification benefits. This is due to two varieties of active ETFs, as well as a play on classic active management. A new Goldman Sachs report highlights this potential.
For starters, the report focuses on in-depth research and dynamic management as a way that active ETFs can provide additional diversification. When looking at passive ETFs and benchmarks, what you see is what you get. But this is not the case for active managers. By selecting stocks, bonds, and other asset classes, they don’t have to look like an index. This can further enhance a portfolio’s overall diversification.
A prime example has been the recent overvaluation of technology stocks within the major indices. Another could be the overweighting of Treasury bonds and notes in the major investment-grade bond indices. Managers can take an active approach to adjust asset weightings and create a more diversified portfolio compared to an index. 1
However, actual stock or bond picking isn’t the only way active ETFs can enhance a portfolio’s diversification. Goldman highlights a new form of active ETF that provides true non-correlated diversification.
According to Goldman, active ETFs that use derivatives are a true game-changer for portfolios.
Derivative investing tends to conjure images of complex strategies and traders with six or so monitors watching trend lines and blinking screens. A derivative is a security that derives its value from an underlying asset or another type of security. Originally, derivatives were used as insurance or to lock in the price of a commodity at a set price for a future delivery date. But futures, options, and CDs trading have exploded. When it comes to ETFs, active management has made derivative-income or buffer/defined-outcome strategies possible for the average Joe at a low cost.
Derivative-income ETFs, also known as covered-call or buy-write strategies, use options contracts to generate income from a portfolio of assets. In exchange for writing call options, investors are paid a premium. According to Goldman, this generates extra income that is not tied to interest rates, unlike bonds, and provides lower volatility and downside protection. The proof of this added diversification and stability has been better returns. Both full- and partial-covered-call equity approaches have outperformed the broader bond aggregate index over the last thirty years.
Source: Goldman Sachs
Another options-based active ETF strategy can help enhance portfolio diversification and return potential. Buffer ETFs use options with regard to their traditional purpose as insurance. Managers of these funds will buy options contracts to track the performance of their underlying indexes, while at the same time sell the call options tied to the same index. This creates a price floor for the fund that kicks in when the market has a drawdown below this amount. At the same time, the options contracts create a cap on gains.
According to Goldman, buffer ETFs provide diversification enrichment in several ways. First, they create a “guaranteed” source of returns that protects equity market drawdowns. This source of returns also functions the greatest during equity drawdowns and acts as a non-correlated source of returns, i.e., a diversified returns source. Secondly, the defined return can act similarly to fixed income’s steady coupon payments. However, because it’s not tied to interest rates, it provides extra diversification. This is particularly helpful when stocks and bonds become highly correlated.
The result is that active ETFs and various new forms of active management can add additional diversification benefits to a portfolio. And these are attributes that passive and index ETFs can not do.
Using Active ETFs To Improve Diversification
Overall, the rise of active ETFs can be seen as a valuable new tool for portfolio construction, offering new ways to build portfolios that meet a wide range of goals. Goldman Sachs’ new report underscores how active management through traditional asset picking and derivatives can serve to make a portfolio better and more non-correlated. With that in mind, adding a dose of active ETFs to a portfolio makes sense.
The question is, how to do it?
Goldman’s report didn’t give any hard recommendations on percentages. Investors utilize these active ETFs as a third allocation in their portfolios. This means reallocating funds from both equity and fixed income to acquire a buffer or option-income fund. The idea is that they form a separate diversified asset class within a portfolio. And with more than 400 of these ETFs on the market, doing that is easy.
Buffer ETFs
These actively managed funds are just some of the buffered ETFs available with several issuers offering different monthly vintages. Theay are sorted by their YTD total return, which ranges from 8.2% to 9.8%. They have expense ratios of 0.74% to 1.05% and assets under management of $144M to $1.21B. None of them pay a dividend currently.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| PJAN | Innovator U.S. Equity Power Buffer ETF - January | $1.21B | 9.8% | 0% | 0.79% | ETF | Yes |
| BUFD | FT Vest Laddered Deep Buffer ETF | $879M | 8.5% | 0% | 1.05% | ETF | Yes |
| JULW | AllianzIM U.S. Large Cap Buffer20 Jul ETF | $144M | 8.2% | 0% | 0.74% | ETF | Yes |
Derivative-Income ETFs
These ETFs were selected based on their exposure to options overlays and derivative mandates. They are sorted by their YTD total return, which ranges from -2% to 7.3%. They have expense ratios between 0.29% and 0.75% and assets under management between $98M and $38B. They are currently yielding between 4.9% and 11.3%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| IDVO | Amplify International Enhanced Dividend Income ETF | $145M | 7.3% | 6.1% | 0.66% | ETF | Yes |
| NUSI | Nationwide Nasdaq-100 Risk-Managed Income ETF | $328M | 3.5% | 8.6% | 0.68% | ETF | Yes |
| JEPI | JPMorgan Equity Premium Income ETF | $38B | 2.6% | 6.8% | 0.35% | ETF | Yes |
| KNG | FT Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF | $3.65B | 2.3% | 8.6% | 0.75% | ETF | No |
| DIVO | Amplify CWP Enhanced Dividend Income ETF | $3.89B | 1.8% | 4.9% | 0.56% | ETF | Yes |
| PBP | Invesco S&P 500 BuyWrite ETF | $98.7M | -1% | 10.9% | 0.29% | ETF | Yes |
| JEPQ | JPMorgan Nasdaq Equity Premium Income ETF | $19.6B | -1.5% | 10.7% | 0.35% | ETF | Yes |
| QYLD | Global X NASDAQ 100 Covered Call ETF | $8.38B | -2% | 11.3% | 0.61% | ETF | No |
For investors, active ETFs can add additional alpha and true diversification to portfolios. The growth of derivatives strategies, such as buffer and options overlay funds, levels the playing field for regular Joes and allows them to achieve better diversification, lower volatility, and steadier returns. That’s wonderful news.
Bottom Line
The growth of active ETFs means that portfolios can now achieve better diversification and add non-correlated assets. Buffer and options overlay funds are two great examples of how investors can do just that.
1 Goldman Sachs (March 2025). How Active ETFs Can Help Investors Fine-Tune Portfolio Construction
