Over the course of the last week, I saw some statements in interviews and articles doubting that actively managed ETFs will deliver on their promise of outperformance for their investors. Some of these market observers who made such comments were targeting explicitly the so-called research enhanced ETFs, as they said, these ETFs do not implement a real active strategy as their allocations differ only slightly from the allocations of their underlying indices.
First of all, some of these comments were on the level of activity of the respective portfolio managers, as the commentators were claiming that these ETFs are not managed actively in the sense of an active portfolio manager who has opinions on markets, sectors, and single securities, as well as a high conviction on his security picks. This argument is absolutely right. But the label of the respective ETFs (research enhanced, etc.) doesn’t claim that these ETFs are differing widely from their underlying index. By the way, this is exactly the reason why these ETFs are so successful when it comes to gathering new assets, since especially institutional investors like to invest in products which are not differing too far from their index (which is in many cases also the index which the respective investor is measured against), but still have the potential for an outperformance. This is because these kinds of ETFs are taking a lower share from the risk budget from the portfolio of the (institutional) investor, than an actively managed ETF or mutual fund without any restrictions with regard to its allocations.
This means labeling these ETFs as index huggers is wrong, as they don’t claim to invest free from any index or benchmark restrictions. That said, one needs to bear in mind that there are tons of so-called actively managed mutual funds available to investors in Europe, and around the world, which are claiming to be actively managed and are charging a fee in line with other actively managed products which are in fact managed very close to an index. To me this raises the question of why some market observers are blaming products which are true to label—for being true to label—while they don’t speak about other products who are not?
For me, these statements and comments sound like somebody is trying to find arguments against ETFs because they may suffer outflows and do not offer an ETF by themselves.
By the way, one should not forget that the fund industry in Europe has just started to launch actively managed ETFs and some “real” active managers are in the process of bringing actively managed ETFs without a reference to an index or benchmark to the market. Maybe those critiques may vanish once the market segment of actively managed ETFs has matured.
That said, the second topic which has been discussed a lot over the last few weeks and months is the performance of actively managed ETFs. It seems like some market observers are very keen on the results of actively managed ETFs compared to their benchmarks and are ready to put out some negative headlines, as they may want to compromise actively managed ETFs.
This leads to questions of why somebody would expect to see different results from actively managed ETFs compared to actively managed mutual funds? A strategy or a manager won’t become better relative to its benchmark just because it is offered as an ETF. Hence a manager who is not outperforming his benchmark in a mutual fund will likely not outperform his benchmark just because he wrapped his portfolio into an ETF.
This means once we have a large enough sample of actively managed ETFs and a long enough evaluation period, one should expect somewhat the ratios of outperforming and underperforming products in the segment of ETFs, as in the segment of mutual funds. That said, one needs to bear in mind that actively managed ETFs have, in general, lower total expense ratios (TERs) than mutual funds, which may lead to a slightly higher number of outperforming ETFs, as the respective portfolio manager has a lower cost burden to overcome before generating returns for the investors.
To sum this up—just because an ETF claims to be actively managed, it does not mean that the respective strategy will produce better outcomes than the same strategy wrapped in a mutual fund. That said, as the ETF might have a lower total expense ratio than the mutual fund, it may outperform the mutual fund by this margin, but this still doesn’t mean that it will outperform the underlying market. So, investors need adjust their expectations on active ETFs accordingly and analyze the performance of any similar mutual funds offered by the same promoter, if available. Otherwise, choosing an actively managed ETF should follow the same rules and guidelines than the selection of an actively managed mutual fund.
The views expressed are the views of the author, not necessarily those of LSEG.
This article is for information purposes only and does not constitute any investment advice.
