The Walking Dead Return [as Active ETFs]
by Michael Mell, Director for Custom Indices, S&P Dow Jones Indices
In AMCâs âThe Walking Dead,â we meet Rick Grimes after he awakens from a coma to find himself in post-apocalyptic world filled with legions of zombies. Rick calls these zombies âwalkers,â but as each season goes by (season seven starts this October) different groups name them other things, like biters, roamers, lurkers, etc. The names donât matter because there are more of them each day, all walking around aimlessly until they meet survivors in Rickâs group, who generally dispatch them efficiently.
In much the same way, active management is still losing out to passive index management, despite the numerous active funds that appear year after year. Â According to the 2015 year end SPIVAÂź Europe Scorecard, which measures the performance of actively managed funds against their benchmarks, 84% of U.S. active funds underperformed the S&P 500 and an astounding 98% of U.S. active funds trailed their benchmark over the past 10 years.[1] Â Interestingly, Moodyâs recently found that the proliferation of funds is one cause for lackluster returns, as âthere are more than 9,250 mutual funds and 10,000 hedge funds, compared with 3,691 stocks in the Wilshire 5000 and 505 stocks in the S&P 500Âź,â[2] and that this âovercapacity leads to investment mediocrity, since true talent is limited and size works against the investor in the form of increased transaction costs and difficulty in identifying scalable investment opportunities.â[3]
So what are all these active managers going to do? Admit defeat and begin considering index-based solutions? Noâinstead, the industry has decided to turn ETFs, arguably the most efficient vehicle for making low-cost, index-based solutions available, into a mechanism for spreading active management. The walking dead are returning and there is no stopping them.
The SEC recently approved generic listing standards for actively managed ETFs, which currently ârepresent a small portion of the more-than $2 trillion invested in U.S. ETFs, with about $26 billion in assets, according to Morningstar Inc.  Still, the number of such funds sold has mushroomed to 154 this year from 40 five years ago and just 14 in 2008.  Actively managed funds have largely underperformed their passive rivals.â[4] Itâs important to understand that âthe main distinction between active and passive, or index-based, ETFs is that the underlying holdings in the active ETFs are dynamic and managed similar to the way a mutual fund portfolio is managed.â[5]  To be fair, âsponsors of active ETFs say they are more attractive than actively managed mutual funds because they typically have lower management fees and feature a tax structure that makes them less costly than mutual funds.â[6] Perhaps performance will improve only because the costs are lower? However, even âafter subtracting fees, returns from active management tend to be less than those from passive management.â[7]  Also, when thinking about active management in general, itâs key to note that âeven when fund managers succeed in outperforming their peers in one year, they cannot easily repeat the feat in successive years, as many studies have shown.â[8]
So donât expect these zombie active ETFs to come to life all of a sudden just because the wrapper for their active management approach is different. Instead, you can expect to wake up one day like Rick Grimes and find that the more than 9,250 mutual funds and 10,000 hedge funds have been reanimated as active ETFs, most of whose strategies will likely continue to underperform passive investment management.
[1] Â Year- End 2015 SPIVAÂź Europe Scorecard
[2] Â Bloomberg News, http://www.fa-mag.com/news/more-pain-for-stock-pickers-as-moody-s-sees-big-shift-to-passive-28188.html?utm_source=FA+Subscribers&utm_campaign=19c5b45ee2-FAN_Mutual_Fund_News_072716&utm_medium=email&utm_term=0_6bebc79291-19c5b45ee2-222305257.
[3] Â Ibid.
[4] Â Ackerman and Sarah Krouse, http://www.wsj.com/articles/sec-set-to-fast-track-certain-etfs-1469209240.
[5] Â Jeff Benjamin, http://www.investmentnews.com/article/20160728/FREE/160729936/active-etfs-produce-few-stars-and-even-fewer-fans.
[6] Â Ibid.
[7] Â SPIVA Institutional ScorecardâHow Much Do Fees Affect the Active Versus Passive Debate?
[8] Â Jeff Sommer, http://www.nytimes.com/2016/04/24/your-money/the-high-fees-you-dont-see-can-hurt-you.html?_r=1
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