Active ETFs Miss The Mark

June 19, 2018

[This article appears in our July 2018 issue of ETF Report.]

Even as ETFs have gone mainstream, active ETFs remain a Wild West, full of frontiers to explore and claims to stake. Though there are now 225 actively managed ETFs on the market, they total just $59 billion in assets under management (AUM)—or 2% of the $3.5 trillion invested in ETFs as a whole. 

Interest in them appears to be growing, however. Combined, active ETFs have brought in $20 billion in new net inflows over the past 12 months, as of this writing.

But do the returns of active ETFs justify all this investor excitement? We crunch the numbers to find out.

Tiny Assets, Outsized Flows
First, let’s set the scene. By far, the largest active ETF is the PIMCO Enhanced Short Maturity Active ETF (MINT), with $9.3 billion in AUM. (MINT also had the largest inflows of the past year, of $2.3 billion.) Other big active ETFs include the iShares Short Maturity Bond ETF (NEAR) and the First Trust Preferred Securities & Income ETF (FPE) (see Figure 1).

 

 

It’s easy to see the common denominator here: fixed income. All but two of the 10 largest active ETFs are bond funds; fixed income also accounts for eight of the 10 active ETFs with the largest inflows over the past year (see Figure 2).

 

 

The “why” makes sense: Even dedicated passive investors may seek active management in the bond market, a notoriously complex marketplace where literally millions of individual bonds trade daily. An active manager acts as a sort of helping hand, a Sherpa in the wilderness that can tease out effective exposure and mitigate risk. It’s also why you see active ETFs cover other market segments with steep learning curves: commodities, alternatives, even certain highly specific themes, like genomics or blockchain.

But does that helping hand actually help?

Some Outperformers Exist
The good news is that, of the 166 active ETFs with track records longer than one year, a good chunk of them—31—either outperform the broader market, as measured by the SPDR S&P 500 ETF Trust (SPY), or come within 1 percentage point of doing so (see Figure 3).

 

 

The three biggest outperformers were funds by ARK Invest: the Ark Web x.0 ETF (ARKW), which rose 54.06%; the ARK Innovation ETF (ARKK), which rose 52.92%; and the ARK Genomic Revolution Multi-Sector ETF (ARKG), which rose 41.02%.

In the case of ARKW and ARKK, at least some of that outperformance can be traced to an allocation to the Bitcoin Investment Trust (GBTC). Those positions, which hovered between 6-10% throughout 2017, resulted in an 87% gain for both funds that year. However, ARKW and ARKK have since trimmed their bitcoin holdings to almost nothing.

Other active outperformers include three commodity ETFs: the ProShares K-1 Free Crude Oil Strategy ETF (OILK), which rose 35.8%; the ETFS Bloomberg Energy Commodity Longer Dated Strategy K-1 Free ETF (BEF), which rose 30.3%; and the iShares Commodities Select Strategy ETF (COMT), which rose 25.6%.

All three ETFs have significant allocations to energy, making them well-poised to ride the dramatic increase in crude oil prices over the past year. In addition, for whatever it’s worth, all three use a Cayman Islands structure to avoid Schedule K-1 forms at tax time.

Cloud In The Silver Lining
You’ve probably already spotted the bad news in this data, however. Those 31 ETFs that outperformed over the past year? They represent just 19% of all active funds on the market. The remaining 81% underperformed SPY—and not by a little bit, either.

Over the past year, the average active ETF returned just 6.3%, compared to SPY’s 14.7% rise. The worst performer, the REX VolMAXX Short VIX Futures Strategy ETF (VMIN), lost an incredible 84.2% of its value.

Now, some of the underperformance is undoubtedly linked to the fact that so many active ETFs are fixed-income funds, and fixed income usually underperforms equity, no matter how good the active manager is. And in an apples-to-apples comparison of active ETFs in individual asset classes to their typical segment benchmarks, active management outperforms—but only sometimes.

For international equities and bonds, active ETFs on average outperformed their passive benchmarks, by 2.6% and 1.7%, respectively, over the previous 12 months. Meanwhile, passive benchmarks outperformed active funds in both U.S. stocks and commodities, by 4.5% and 7.6%, respectively.

Active Misses Mark Long Term
The problem is, it’s hard to tell if active’s outperformance has staying power. Many active ETFs simply don’t have a long-enough track record yet to allow us to extrapolate meaningful conclusions about their three-, five- or even 10-year performance. 

Consider fixed income. It’s the most popular ETF segment for active management, with 81 ETFs. Yet only a fifth of those funds have track records of five years or longer. Now, of those that do, the average return lags that of the Bloomberg Barclays U.S. Aggregate Bond Index (the “Agg”), 1.6% to 1.9%. But 16 funds out of 81 is hardly a representative sample.

It gets even harder to evaluate active management’s long-term success in asset classes without any readily available passive benchmark. Active alternatives ETFs have a 0.82% return over the past year, while asset allocation ETFs have returned 6.6%. Is that good compared to a passive approach, or not? After all, it’s worse than SPY’s returns—but is that a relevant data point, or just noise? 

Real Downside Of Active: Cost
One thing is certain, however: The modest outperformance offered by active ETF managers in both international equity and bonds is significantly eroded by these ETFs’ expense ratios.

The average active bond ETF has an expense ratio of 0.52%, while the average active foreign stock ETF costs 0.83%. That’s a lower price tag than you might find in the mutual fund space, but it’s an exorbitant cost for ETFs, where core passive exposure in both asset classes can usually be found for 0.15% or less.

What’s more, many of these smaller, niche active ETFs don’t appear on commission-free trading platforms, meaning investors must pay more in trading costs to both enter and exit these funds.

 

 

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