Every once in a while, the markets like to remind us they don’t always follow a straight line upward. From the Great Recession to the pandemic/COVID-19, there are sometimes shocks to the system. Right now, the shock is coming from increased uncertainty due to pending tariffs, high inflation, and contracting economic conditions. And that shock is reinforcing the idea that volatility and investing go hand in hand.
But how we deal with the volatility is key.
The secret could lie within active ETFs. Active management can go a long way in fighting volatility. Thanks to some unique advantages over passive investment strategies, active ETFs are better suited to fighting volatile markets. Active management can play a bigger role in increasing returns, reducing losses, and smoothing out the rough rides during these times, compared to other periods.
With rising volatility and uncertainty, active ETFs could shine.
A Jump in Uncertainty
If there is one thing investors hate, it has to be uncertainty. Right now, there is plenty of uncertainty with regard to the state of the U.S. and global economies.
Thanks to the on-again, off-again, on-again tariff proposals from the Trump Administration, investors have begun to worry about how the world’s economy will play out. This has affected a variety of asset classes and end markets. Businesses and consumers have begun to react to day-to-day changes and proposals. All of this has resulted in very high price swings across market benchmarks and asset classes.
And you can see this in the wild swings and changes to the so-called fear index.
The Chicago Board Options Exchange Volatility Index—also known as VIX—measures the market’s expectations of stock price changes over the next 30 days. When the VIX is wildly swinging, investors predict tough times and big changes ahead. That’s what’s going on. On Liberation Day and when the Trump Administration first announced its wide-sweeping tariff policies, the VIX surged to 60.13. That was the highest closing level since the COVID-19 pandemic over five years ago. It has fallen back between a range of 20 and 40.
You can see from the CBOE how the VIX has swooned over the last 90 days.
Source: CBOE
The problem is big price swoons up and down aren’t great for portfolios. Volatility is a huge killer to returns.
Comparing two $100 portfolios over four years—one with high volatility and one with low volatility—underscores how the smoothness of the ride determines returns. For example, portfolio A has low volatility. It never grows by more than 15% per year, but it also never falls by more than 5%. Portfolio B has much higher volatility. It achieves returns of 25%, but it also sees much greater losses of 15%. They both average 5% annual gains over a period. However, Portfolio A will be worth more: $119 vs. $113. The key is in the compounding and the higher percentage of losses of Portfolio B. Portfolio A manages to grow by a CAGR of 4.5%, while Portfolio B grows by a CAGR of just 3.1%. 1
Active ETFs to Help Reduce Volatility
So, the bounciness of a portfolio matters to returns, and limiting that bounciness is paramount to getting better long-term results. With volatility currently picking up, investors should be thinking about this during their portfolio construction.
Active ETFs can play a significant part in reducing overall volatility.
Indexing is wonderful in that it provides access to the total market simply. The issue is investors can’t choose their ride. With indexing, you get both the good and the bad. Because of this, investors are subjected to the overall whims of the market. This includes changes and shocks to volatility. And given how most indexes are market-cap-weighted, a few stocks can significantly influence their direction and price swings. You can see this today. The so-called Magnificent Seven now make up just over 32% of the S&P 500. The current price swings in these stocks have directly influenced the overall volatility of the broader market index.
However, active managers don’t have to look like the index. They are free to overweight, underweight, or even exclude various stocks when they build their portfolios. This can naturally help reduce the volatility of a portfolio and reduce drawdowns.
Active management has a few other tricks to help reduce the volatility of a portfolio.
This includes a focus on income. When looking at a broad market index, dividends are an afterthought. They are what they are. But an active manager can focus on dividends, a core component of their strategy. This is important as dividend stocks tend to be less volatile than non-payers, and those payouts can help reduce losses. Getting 2% to 4% in cash can add a buffer to the portfolio’s returns.
Moreover, unlike an index—which has to be fully invested—an active manager can allow cash to build up or sell investments at will. Having a buffer of cash or increasing cash positions during periods of heightened market risk can prevent drawdowns, limit losses, and reduce the other volatility of a portfolio.
Finally, active managers can use derivatives and options to smooth out returns. The latest trends in active management remain options overlay, covered calls, and buffer strategies to reduce the volatility of a portfolio. These new tools can be used effectively to reduce the bounciness and smooth out an investor’s ride. This is something a passive index cannot do.
Go Active to Reduce Volatility
For investors, the surge in market volatility is not necessarily a good thing. Over long periods, increased volatility can seriously reduce returns. That means fighting it needs to be a priority. To that end, enhancing an index fund or core holding with a dose of active ETFs makes a bunch of sense.
Ultimately, the tools available to active managers can provide a smoother ride than simply owning a passive index.
Popular Active Equity ETFs
These ETFs represent some of the largest active equity ETFs around. They are sorted by their YTD total return, which ranges from -12.2% to 1.2%. They have expense ratios between 0.15% and 0.60% and assets under management between $236M and $40B. They are currently yielding between 0% and 14%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| CGDV | Capital Group Dividend Value ETF | $14.2B | 0.5% | 1.2% | 0.33% | ETF | Yes |
| FLV | American Century Focused Large Cap Value ETF | $236M | 0.4% | 1.9% | 0.42% | ETF | Yes |
| JEPI | JPMorgan Equity Premium Income ETF | $40.2B | -0.4% | 10.6% | 0.35% | ETF | Yes |
| DFLV | Dimensional US Large Cap Value ETF | $1.57B | -2.6% | 1.7% | 0.22% | ETF | Yes |
| DFUV | Dimensional US Marketwide Value ETF | $11.6B | -3% | 1.7% | 0.21% | ETF | Yes |
| CGGR | Capital Group Growth ETF | $10.4B | -4.5% | 0.4% | 0.39% | ETF | Yes |
| JEPQ | JPMorgan Nasdaq Equity Premium Income ETF | $23.4B | -4.7% | 14% | 0.35% | ETF | Yes |
| AVLV | Avantis U.S. Large-Cap Value ETF | $5.82B | -5.1% | 1.7% | 0.15% | ETF | Yes |
| DFAC | Dimensional U.S. Core Equity 2 ETF | $33.1B | -5.3% | 1% | 0.17% | ETF | Yes |
| TCHP | T. Rowe Price Blue Chip Growth ETF | $1.06B | -6.2% | 0% | 0.57% | ETF | Yes |
| DFAT | Dimensional U.S. Targeted Value ETF | $10.6B | -10.1% | 1.3% | 0.28% | ETF | Yes |
| FBCG | Fidelity Blue Chip Growth ETF | $3.98B | -11.3% | 0.14% | 0.60% | ETF | Yes |
| AVUV | Avantis U.S. Small-Cap Value ETF | $15.5B | -12.2% | 1.6% | 0.25% | ETF | Yes |
All in all, active management makes a ton of sense with regard to volatility smoothing. By not looking like the index, focusing on income, and potentially using options, active managers can do things an index cannot do. And that helps reduce the overall volatility of a portfolio. With volatility rising, now is the time to reduce this force and go active.
The Bottom Line
Active management can be a great tool for reducing volatility. By using active ETFs, investors can take advantage of additional tools active managers have to help smooth out a portfolio’s ride. Ultimately, that’s a good thing for long-term results.
1 AB (April 2015). The Paradox of Low-Risk Stocks
