Ask a physical therapist or kinesiologist: core strength prevents many health or movement issues. Similarly, building an investment portfolio requires a strong core. In portfolios, a good core handles most of the heavy lifting and asset allocation. Traditionally, building a strong core meant choosing low-cost, passive funds.
However, investors may want to rethink that stance.
Thanks to the growth of active ETFs, investors may want to rethink how they build their core portfolios. The rise of systematic indexing and active-light ETFs has changed the game for core portfolio building. Today, investors can get extra returns from their core without taking on new risks.
A Quick Primer On Your Core
While quick gains do happen, most investors build wealth over the long term through a diverse set of funds that slowly grow and generate returns. The funds doing the heavy lifting are considered their core portfolio.
In today’s world of Modern Portfolio Theory, core portfolios are made up of a variety of asset classes—usually stocks, bonds, real estate, and other alternatives—and form the bulk of an investor’s holdings. These core holdings will provide historically stable and reliable returns over the long haul. At the same time, core holdings tend to be broad. Stock funds will cover the entire universe of large caps, while bond funds will focus on the entire market of investment-grade bonds.
Finally, core holdings work in concert to provide diversification benefits and improve long-term returns. When one asset class zigs, another will zag. This helps limit losses and grow wealth over time.
The concept and use of core portfolios really took hold as passive and index funds gained prominence. With broad, passive funds, investors could own wide swaths of the market cheaply and let compounding and asset allocation work for them. The invention of ETFs only exacerbated this trend as investors flocked to the low-cost vehicle for broad market exposure.
Not So Fast…
As passive ETFs have become the core portfolio holding du jour, active strategies have been removed to the wayside. Many investors have chosen not to use them, or if they do, they’ve become so-called satellite positions designed to provide just a little additional alpha to a portfolio’s returns.
And it’s easy to understand why this has been the case. Higher fees and lower returns have made active a losing bet versus passive. Why use them as the main building blocks when they can’t beat passive strategies in the core?
However, the growth of active ETFs is now starting to change that thinking. It turns out that active ETFs and strategies can very much serve as core portfolio building blocks. In fact, they may be better than passive cores on a number of fronts.
For starters, despite being broad and offering plenty of market coverage, passive ETFs may have some drawbacks and additional risks that investors have not considered. According to asset manager J.P. Morgan, this includes exposure risk. 1
Most passive ETFs track benchmarks that are market cap weighted. This places more emphasis on larger firms, high-performing stocks, and major bond issuers. For example, the five largest stocks in the S&P 500- NVIDIA Corp, Microsoft Corp, Apple Inc, Amazon.com Inc, and Broadcom Inc -now make up roughly a third of the entire index. That’s a huge amount of concentration risk and additional volatility that investors are now exposed to.
Secondly, J.P. Morgan argues that investors may actually have unintentional gaps or overlap when they choose passive investments. By selecting different index funds, they may be missing wide swaths of the market or perhaps owning the same swath. This is especially true in the fixed income space where most bonds and issuers are not actually included in major benchmarks.
But active management is different. They can deviate from a market-cap weighted index and help reduce exposure risks and reduce overlaps. Moreover, volatility could be inherently lower as less focus is placed on the top firms in an index.
This plays out in the new way of active ETFs dubbed systematic or enhanced indexing. Here, managers will take an index and apply small active massages to the benchmark. This can include applying value screens, looking for strong balance sheets, or scoring momentum and dividend yields. Managers use these systematic elements to purchase stocks or bonds to tweak an index. By being benchmark aware, managers can deliver steady index-like beta to a portfolio with a consistent extra boost to performance.
And it works! For example, the Dimensional U.S. Core Equity 2 ETF is an enhanced equity strategy based on the Russell 3000 index and holds over 2,600 stocks. The ETF’s returns have been significantly correlated to the index but has managed to outperform it slightly, and it’s done so with lower volatility.
Then there are costs to consider. The fee hurdle for active management continues to plunge as expense ratios for active ETFs have now fallen in-line with many passive funds. In fact, you can get some active ETFs at a lower cost than some passive ETFs. Adding in the tax savings that active ETFs can provide, youhave a recipe for core portfolio exposure.
Active ETFs In Your Core
With the rise of enhanced indexing and the ability of active managers to overcome some of passive’s major issues, they could be a great core portfolio offering. This could be complimenting passive funds or even replacing them in some instances. Investors certainly have plenty of choices to use them in a core. This chart from State Street shows that more than 105 different Morningstar fund categories now have active ETF exposure.
Source: State Street
Enhanced Active ETFs
These ETFs provide exposure to enhanced or fundamental strategies with an active touch. They have expense ratios between 0.17% and 0.28% and assets under management between $4.5B and $38B. They are sorted by their YTD total return, which ranges from 1.9% to 15.8%. They are yielding between 0.3% and 4.2%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| FELG | Fidelity Enhanced Large Cap Growth ETF | $4.5B | 15.8% | 0.30% | 0.19% | ETF | Yes |
| FELC | Fidelity Enhanced Large Cap Core ETF | $5.4B | 13.2% | 0.90% | 0.19% | ETF | Yes |
| DFAC | Dimensional U.S. Core Equity 2 ETF | $38B | 11.5% | 1.1% | 0.17% | ETF | Yes |
| DFUV | Dimensional US Marketwide Value ETF | $12.3B | 9.5% | 1.5% | 0.21% | ETF | Yes |
| DFCF | Dimensional Core Fixed Income ETF | $7B | 7.8% | 4.2% | 0.18% | ETF | Yes |
| DFAT | Dimensional U.S. Targeted Value ETF | $11.6B | 3.3% | 1.9% | 0.28% | ETF | Yes |
| AVUV | Avantis U.S. Small-Cap Value ETF | $18.6B | 1.90% | 1.90% | 0.25% | ETF | Yes |
All in all, core portfolios used to be dominated by passive ETFs and indexing. But not anymore. Today, active ETFs could be a core portfolio’s best friend. By eliminating some of the major hurdles with passive indexing, active ETFs could improve core portfolios and enhance gains while reducing risks. For investors, that could be a major win-win for building wealth over the long haul. Consider evaluating your portfolio today and take advantage of the growing array of active ETF options to help strengthen your core.
Bottom Line
A core portfolio is a major driver of returns and asset allocation. Historically, this has been the realm of passive funds and ETFs. But now, with active ETFs starting to gain steam, they could be a better bet for your core. Eliminating some major passive issues, active ETFs have the ability to drive returns and outperform at the core.
1 J.P. Morgan Asset Management (March 2025). Myth busting #4: Active ETFs don’t make good core investments
