While ETF’s have been around for a few years now and have already gained a lot of market share, almost all of them are still passive ETF’s. They are passive in the sense that they track an index, usually a known one such as the S&P500, but also very often less known ones. An ETF like UNG (Natural Gas) tracks an index, a custom one that tracks futures contracts on a pre-determined schedule. They are custom but you do know exactly what you are buying when you have a position on these.
By contrast, Active ETF’s are asked to beat indexes the same way a hedge fund manager or many mutual fund managers must do so. Of course, they all have a strategy that is generally disclosed. You will not know in advance what the fund will buy but you will know what is trying to accomplish. For example, buying a “short bias” ETF would make sense in many circumstances. But don’t expect the fund to beat indexes in an up year.
So how are they doing?
In terms of performance, it is still very early to tell. Some are doing better than passive funds, some are not. In any case, it’s very difficult to judge these funds on a few months or even a year. Like any other fund, they will need to build a history in order to get more investors involved.
As far as the number of funds, there are more opening each month but I’m still a bit surprised to see there are not more funds out there. My best guess would be that since ETF’s took off so quickly, issuers put all their energy into the easier ones, those that can be promoted in a clear way because they track a precise index. The active ones require a lot more time and energy and will likely not gain much interest until they have a track record of a few years.
How to compare their performance?
I would say that in general, each fund needs a different benchmark depending on how it was defined. A fund that is long only and invests in Nasdaq stocks should probably be compared to the Nasdaq index or or to QQQQ. But others will be a lot more difficult to judge.
Powershares has a few funds that are more easily comparable and they have been fairly strong so far and outperforming their passive equivalents. The question of course if it will keep up. My guess would be it will be similar to mutual funds and hedge funds; most will fail to deliver but the best ones will generate big returns for their investors.
One of the major concerns for active ETF’s is the fees structure. Like other ETF’s they usually have a flat percentage fee. That is fairly easy to evaluate. The other thing to look at is the presence of “incentive fees”. These fees can add up very quickly because they are generally a portion (generally 20%) of the performance above a specific benchmark. These can add up very quickly and should at least be considered. Not to say that you should not invest though. One of the largest hedge funds, SAC Capital, charges 50% of their return above benchmark. Crazy? You bet! But when a fund returns over 20% annually, investors are generally willing to go on the ride.
While I am personally on the sidelines right now, I am far from ruling out active ETF’s and could consider an investment in the next few months. How about you? Have you tried one out? Considering one?