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Home > Investments > ETFs & Trackers

By Manooj Mistry | Published Jul 16, 2012

Assessing active ETFs

The exchange traded fund (ETFs) world is changing, as providers increasingly launch actively managed products to compete with more traditional fund providers.

At first glance the increasing popularity of ETFs could be seen as having been built on the back of an investment philosophy that fundamentally rejects active management and the pursuit of ‘alpha’ or outperformance of an index. The premise of offering a ‘beta’ product – or one which tracks an index – partly comes down to the following: markets are relatively efficient, which means it is difficult for an active manager to outperform the market consistently over time. There is merit to this argument.

Is active management worth it?

Although there are undoubtedly many talented active asset managers who generate ongoing superior returns for their investors, a number of studies have suggested that consistent outperformance is generally elusive. For example, Standard & Poor’s conducts a regular piece of research called the S&P Indices Versus Active Fund Scorecard (SPIVA), which provides performance comparisons for actively managed US mutual funds.

The Mid-Year 2011 SPIVA research shows that in the three years up until the middle of 2011, 64 per cent of actively managed large-cap funds were outperformed by the S&P 500 index, 75 per cent of mid-cap funds were outperformed by the S&P MidCap 400 index, and 63 per cent of small-cap funds failed to match the performance of the S&P SmallCap 600 index.

Among international equity categories, 57 per cent of global funds, 65 per cent of international funds and 80 per cent of emerging markets funds failed to outperform their benchmarks. It is no surprise then that passive funds, as a low-cost alternative, have grown in popularity.

Active ETFs growing in popularity

It may therefore seem counterintuitive that an increasing number of ‘alpha ETFs’ are coming onto the market. However, it is clear that investors still see value in active management.

Alpha ETFs constitute a small part of the ETF industry, comprising just 0.9 per cent of the European ETF market and 0.5 per cent of the US market. But the nominal numbers are growing. By the end of 2011, there were roughly 65 alpha ETFs listed in Europe and the US, up from less than a handful in 2006, according to Deutsche Bank’s ETF market researchers.

Recently there has been a flurry of high profile launches of actively managed ETFs. At the end of April State Street launched three actively managed ETFs in the US that aim to beat market indices by owning a portfolio of underlying ETFs.

In March, bond guru Bill Gross launched his Pimco Total Return ETF, again listed in the US. The European market is developing too. So how does this trend tie in with the rise of ETFs?

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