Should You Buy Actively Managed ETFs?
Since exchange-traded funds (ETFs) were launched more than a decade ago, the trend in investing has been towards low-cost investing. People are shunning investments which charge an arm and a leg to do something many people feel they could do more easily and cost-effectively. This is the result of increased competition in the investment world or what I like to call – the democratization of the investment space.
The most direct consequence of this is how investments in index mutual funds have changed. Investors in index mutual funds – which invest client money passively to track an index – started comparing that to investing in Index ETFs which are identical to index mutual funds in terms of strategy, but are cheaper, more tax-efficient, more liquid and more transparent than index mutual funds. Given a choice of the two, it sounds like a no-brainer right? Most investors agreed and have poured money into Index ETFs, with global ETF assets crossing the $1 trillion mark recently. And in fact, in 2009, for the first time, Index ETFs had more assets than index mutual funds.
But in the broader scheme of things, only about 10% of assets are passively-managed. Active management is alive and well as the large majority of assets continue to lie in actively-managed mutual funds where portfolio managers are striving to outperform their benchmark rather than just matching its performance. This is despite volumes of research that suggests active managers have a hard time outperforming indices.
So let’s start by addressing a fundamental question up front – why do people continue to look for active management?
Active Management: What’s the pull factor?
85-90% of assets are still in actively-managed mutual funds. Part of the reason for that is the existing difference in market size – with so much money in active strategies, active managers have greater resources to market and attract investors than passive strategies. And active managers have been around for much longer too.
However, the bigger reason I feel, is the need for people to strive for higher performance – they just don’t want to “settle” for the benchmark return. Allow me to draw an analogy: If you are given a choice between receiving a guaranteed $25 or a 10% chance to win $200, I’m willing to bet that most people will take the chance, despite the odds against that choice. People believe in their ability to beat the odds and this same logic carries over to investing. Investors believe that they have the ability to pick the star manager that will outperform the benchmark and hence continue to plow money into active mutual funds even though on average, active managers may not be beating their benchmarks.
This investor mindset creates an overflow of money and especially fees accruing to active mutual funds even though they often charge 1-2% per year, while only disclosing their holdings quarterly and trading just once a day. When you take into account the effect of compounding, these fees can result in huge difference in long-term performance. At this stage, you might ask, then why do investors continue to put their money in these active mutual funds? They do it because, up till recently, if investors wanted an active manager – which most people do for the reasons described above – the only choice they had was to go with mutual funds. They could have moved their investments into Index ETFs but those structures would not allow for active management. In other words, mutual funds had a monopoly on active management. But that is finally changing.
Actively-Managed ETFs: What’s In It For You?
Active ETFs arrived on the financial scene in 2008 once the SEC approved the launch of these products. Today, there are 17 Active ETFs in the United States and also a bunch in Canada. You can visit EtfsHub to find a full database of these Active ETFs and their details.
These ETFs are different from traditional ETFs because the portfolio managers behind these funds are not just looking to track ...
