Active ETFs: broadening the sources of portfolio returns

Talking Heads with Vincent Bérard

Daniel Morris: Hello, and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing active ETFs (exchange-traded funds). I’m Daniel Morris, Chief Market Strategist, and I’m joined today by Vincent Bérard, Head of Product Strategy.

Welcome, Vincent. Thanks for joining me.

Vincent Bérard: It’s great to be here.

DM: One of the more sustained trends we’ve seen in investing over the years is the increasing popularity ETFs. Alongside that, we’re seeing a lot of innovation, and we’ll be talking about that around active ETFs today. In your view, Vincent, why are investors looking beyond traditional equity bond portfolios?

VB: For a long time, the default to build a portfolio was a balance between equities and bonds, whether 60% bonds and 40% equities or 70/30. The logic was that when shares fell, high-quality bonds would usually hold up. But that relationship is not a ‘law of nature’.

In 2022, global equities and bonds both fell at the same time and by more than 15% following inflation and rising interest rates that hit both asset classes.

That was a reminder that diversification depends on where returns come from. To put this into perspective, the correlation between US bonds and equities reached almost 50% that year and remained at around 40% in 2023. After two years of correlation around zero percent in 2024 and 2025, we are now observing, in 2026, a correlation of returns around 40%.

Investors are increasingly asking, “Where does my return come from? How independent is it from the rest of my portfolio, and how can I truly diversify further my returns?” There are two broad answers, in my view.

The first is liquid alternatives – strategies that seek to earn returns from assets or portfolios that behave differently from the broad market, so they can add a new source of returns. They are typically accessed through a discipline[d] and quantitative model. Popular examples are managed futures and equity long-short factor investing.

The second is income or outcome-orientated strategies to generate regular cash flow but from a different source of returns, typically from option premiums. Outcome-orientated strategies aim to shape the range of possible returns over a set period. For example, they can absorb an initial part of losses in exchange for capping gains. Both come with trade-offs, and we can speak about these in a moment.

The common thread is a shift from “how many asset classes do I own?” into “what drives each part of my portfolio?”

DM: One of the topics that you mentioned – managed futures strategies – can you tell us more about them and why some investors see it as an interesting option?

VB: A managed futures strategy or portfolio aims to follow trends in a systematic way by investing in a model-driven dynamic portfolio of liquid futures. What this means is, rather than predicting what may happen in the markets based on macro or fundamental analysis, it follows price.

If the market has been rising for a sustained period, the model tends to go long. If it has been falling, the model tends to go short. It’s applied through futures across many markets – equities, bonds, currencies and commodities, typically. Why do investors value it?

First, diversification: it draws on many markets and does not depend on the forecast. It can behave differently from a traditional portfolio.

Second, convexity: trends can develop in both directions, including during sharp sell-offs, so the strategy can benefit when markets move sharply up, but also down. In periods of pronounced trends such as inflation-driven or rate-hike cycles, trend strategies have historically been an important contributor.

Going back to the example of 2022, managed future strategies did very well that year, keeping typically long commodities position and short bond exposures. I think the average return of managed future strategies that year was north of 20%. And the first nine months of 2026 showed a similar environment of pressures on bonds and oil markets.

Managed futures also help in investor portfolios. The average is up 14% this year. When markets move sideways, however, the models can be whipsawed by repeated reversals and lack of direction, so you can have drawdowns and that can potentially last a long time.

This is why managed futures is best judged as a diversifier over full market cycles rather than in any single quarter.

DM: One of the other strategies you mentioned was long-short, which I think for a lot of people brings to mind hedge funds, which is not what we’re discussing today.

VB: Long-short strategies originate from the world of hedge funds, as you mentioned, but it is now being implemented and popularised in more liquid and transparent ways.

It’s anchored into what we call factor investing. Even though not all long-short strategies would be following these type of models, it remains quite a prominent way to do it. Factor investing starts from a simple observation. Some characteristics of companies – such as their valuation, quality, momentum and volatility – have been associated with differences in returns over long periods.

Researchers have studied this effect since the ’70s and they are now widely used by practitioners. A long-short approach builds on this. It buys companies typically with stronger characteristics in these factors and sells those with weaker ones. The attraction is that the return comes from the difference between the two rather than relying only on the market rising.

That can be useful in environments where investors are paying close attention to company fundamentals – as they were during the higher rate periods of ’22 and over the last 18 months. The approach is not without risk. Factors can underperform for years. The environmental
sub-factors can underperform for years, and the environment matters.

For example, when interest rates are very low or even negative, fundamental stock picking criteria is a lot less efficient and can struggle to add value simply because investors do not really look much into the leverage of a company, for example, when rates are near zero.

Short positions also carry their own risks, including the possibility that a shorter stock rises sharply. For investors, the useful question is: What is the rationale behind the construction of such [a] portfolio? What is the approach? And how [does] it behave across different market conditions?

DM: Another innovation you mentioned was defined outcome or buffer strategies. What do they offer?

VB: Buffer or defined outcome strategies are designed to shape the range of possible results. A buffer structure, for example, combines an equity exposure with options so that a minuscule portion of losses will be absorbed, and in exchange gains are capped at a predetermined level.

The main benefit is predictability. A large fall just before or early in retirement, for example, can do lasting damage even if markets recover later because the withdrawals that will be taken are taken from a smaller base. A buffer can help manage this risk of drawdown and can also support capital preservation during an accumulation phase, not only when you’re really close to retirement.

This is because the result is a clear range of outcomes for the given period. The trade-offs need to be clear. The upside is capped. The outcomes depend on when you enter and exit this type of product. Two investors in the same fund or ETF can have different experiences.

The level of the cap above which you give up upside and the protection are also set usually at each period. I would tell investors to read carefully the documentation, understand the products, speak to a professional advisor. But it is a powerful tool to give clarity in potential outcomes and mitigate some potential losses in your portfolio.

DM: Finally, let’s talk about option-based income strategies. What do they offer?

VB: Option-based in-income strategies are quite a broad category. Generally, they aim to earn a premium that option buyers pay. Buyers pay for protection or for exposure through options, and the sellers of these options collect the premium. For investors, this can create a regular cash flow that is a distinct source of return alongside capital growth.

And because it depends on equity options rather than interest rates or bonds, this source of return is less sensitive to rates movements than traditional income solutions.

There’s been quite a strong interest over the last few years on very short-dated options, which expire within days or a week. This market has grown significantly, partly because demand for short-term protection by market participants has increased, so the liquidity of the market has deepened. Because more and more participants use these instruments to hedge short-term risk, they are happy to pay a higher price and a higher premium.

If you are able to benefit from this premium, it’s an interesting way to generate income. Again, fairly de-correlated, fairly diversifying compared to the usual source of return.

Now, with any income strategy, there are scenarios in which this income can be offset by capital losses. The seller typically takes the risk of sudden large market moves, sometimes called gap risk, where the losses can exceed the premiums you collect. So, income can be steady in calm markets and may reverse in stressed ones.

Then again, these instruments are interesting tools in the portfolios, but the details matter, and it is important to look at scenarios and how it fits in in one’s portfolio.

DM: Well, Vincent, thank you very much for joining me.

VB: It was my pleasure.

DM: That’s it for this week’s episode of Talking Heads. If you would like more information about our capabilities in active ETFs, please reach out to your asset management contact or check out Viewpoint, our website for investment insights at viewpoint.bnpparibas-am.com.

Viewpoint brings commentary and analysis in a variety of formats, from investment outlooks to asset allocation videos and podcasts, to help investors make better-informed decisions.

You’ve been listening to the BNP Paribas Asset Management Talking Heads podcast with me, Daniel Morris, and Vincent Berard, Head of Product Strategy.

Please do join me next week. Until then, take care.