Why do investors have conflicting reviews of actively managed ETFs? It may be because they’re actually looking at different products
A recently published piece on ETFdb.com suggests that negative reviews of actively managed ETFs should be taken with a grain of salt.
Most investors are familiar with studies concluding that passively managed funds tend to outperform those that are actively managed in the long run. This is especially true when costs, particularly in the form of fees charged by active fund managers, are factored in. In fact, an S&P Dow Jones study found that over a 10-year investment window that ended in 2015, 82.14% of large-cap managers, 87.61% of mid-cap managers, and 88.42% of small-cap managers failed to outperform their respective index benchmarks on a relative basis. Actively managed funds beat index funds in just one category: U.S. mid-cap value stocks.
Academics attribute the generally better performance of index funds on the Efficient Market Hypothesis, which argues that prices reflect all available information. Given this, index funds represent the path of least resistance to long-run returns, and picking actively managed funds, with their higher expense ratios, would put investors at a cost disadvantage.
The problem is that not all actively managed funds follow the same strategy. Some of them are maintained through active stock picking, which entails higher costs because it requires intensive research and analysis. While this strategy tends to be more costly, it does prove beneficial in certain cases: when the UK referendum result was pending, some actively managed ETFs managed to unload British investments from their portfolio to avoid exposure, while passive funds tracking global indices could not do so at the time.
Other actively managed ETFs simply adjust their indexing strategy: for example, currency-hedged ETFs simply protect against impacts of currency movements on an investment, while smart beta ETFs apply additional criteria, such as valuation or momentum metrics, to basic indexes. The actively managed funds that rely on adjusted indexing are, in effect, basically just passive index funds with a twist, giving them lower expense ratios and relatively better returns.
The debate between advocates of passive and active investing will rage on for some time. But it’s best for both sides to remember that, as with most arguments presented in terms of dichotomies, the reality is not as simple as black and white.
Related stories:
Vanguard unveil first actively managed ETFs in Canada
Making the case for smart beta
Most investors are familiar with studies concluding that passively managed funds tend to outperform those that are actively managed in the long run. This is especially true when costs, particularly in the form of fees charged by active fund managers, are factored in. In fact, an S&P Dow Jones study found that over a 10-year investment window that ended in 2015, 82.14% of large-cap managers, 87.61% of mid-cap managers, and 88.42% of small-cap managers failed to outperform their respective index benchmarks on a relative basis. Actively managed funds beat index funds in just one category: U.S. mid-cap value stocks.
Academics attribute the generally better performance of index funds on the Efficient Market Hypothesis, which argues that prices reflect all available information. Given this, index funds represent the path of least resistance to long-run returns, and picking actively managed funds, with their higher expense ratios, would put investors at a cost disadvantage.
The problem is that not all actively managed funds follow the same strategy. Some of them are maintained through active stock picking, which entails higher costs because it requires intensive research and analysis. While this strategy tends to be more costly, it does prove beneficial in certain cases: when the UK referendum result was pending, some actively managed ETFs managed to unload British investments from their portfolio to avoid exposure, while passive funds tracking global indices could not do so at the time.
Other actively managed ETFs simply adjust their indexing strategy: for example, currency-hedged ETFs simply protect against impacts of currency movements on an investment, while smart beta ETFs apply additional criteria, such as valuation or momentum metrics, to basic indexes. The actively managed funds that rely on adjusted indexing are, in effect, basically just passive index funds with a twist, giving them lower expense ratios and relatively better returns.
The debate between advocates of passive and active investing will rage on for some time. But it’s best for both sides to remember that, as with most arguments presented in terms of dichotomies, the reality is not as simple as black and white.
Related stories:
Vanguard unveil first actively managed ETFs in Canada
Making the case for smart beta
