For quite some time, active management has been almost
exclusively in the domain of mutual funds. Investors used these
funds in order to, hopefully, dial up the return while keeping risk
levels at comfortable levels, relying on a manager’s due diligence
to select securities for a basket. On the other hand, when
investors bought up ETFs, they tended to stick with index-tracking
products such as SPY or AGG, getting exposure to a broad number of
names cheaply and easily. Yet while index-based products have
dominated the ETF market thus far, there are a few areas that
investors have begun to warm up to active funds in exchange-traded
product form.
Namely, investors have embraced active ETFs in the bond and
small cap markets while also taking a closer look at some
international-focused funds as well. Beyond these few examples,
assets have remained low in many of these products and have
remained there for quite some time. This trend is likely due to a
number of reasons largely centered on how the market evolved over
the last few years. First, active ETFs were a little late to the
party, coming several years after many funds had already
established huge asset bases. This keeps trading volumes low for
active ETFs and can often times scare off many investors from these
products. Second, many of the so-called ‘superstar’ mutual fund
managers haven’t moved over into the ETF world, keeping interest
low. Although this could be changing soon, especially if PIMCO
launches an ETF version of its total return bond fund. Lastly, and
most importantly, active funds—be it in mutual funds or ETF
form—have a long history of underperforming their benchmarks. Most
managers fail to match the return of the indexes they match up
against which is a major reason for the huge popularity of
index-based ETFs in the first place (Inside The SuperDividend
ETF).
While often times this is true, there are a few cases in which
the watchful eye of a manager has led to outperformance when
compared to a benchmark. This has even been true in the ETF space,
despite the few choices that exist in many categories at this time.
Below, we take a closer look at three of these examples in which
active ETFs have beaten out their index-tracking counterparts in
terms of year-to-date returns, even when adjusting for
expenses:
PowerShares Active Mega Cap ETF (PMA)
Although mega caps, which consist of some of the largest firms
in the country, are very well researched and liquid segment, this
PowerShares fund has found a way to outperform broad market funds
so far in 2011. The product uses Invesco Institutional’s
proprietary stock model which is based on several factors. These
aspects relate to four key concepts; earnings momentum, price
trend, management action, and relative value. Each stock is ranked
by this model, and the result is a "weight-of-the-evidence"
forecast of the expected annual forecasted excess return for each
stock compared to other stocks within their respective industry for
the next month. The securities are also evaluated for risk using at
least 17 variables, potentially giving the fund a lower risk
portfolio as well (see Three All-Star Leveraged ETFs).
This technique results in a portfolio of about 56 securities
with heavy weightings towards health care and technology. In terms
of top individual holdings, three oil companies, ConocoPhillips
(COP), ExxonMobil (XOM), and Chevron (CVX) take the top three spots
and the rest of the top ten consists of tech and pharma firms.
Interestingly, Wal-Mart (WMT) doesn’t receive a top ten allocation
and actually is absent from the portfolio at time of writing. This
system has certainly paid off for investors in PMA so far in 2011,
as the fund has risen by about 4.7% on the year, more than enough
to offset the fund’s relatively high expense ratio of 75 basis
points.
This return of PMA compares favorably with a number of low cost
options in the mega cap ETF space. The Vanguard Mega Cap 300 Value
Index ETF (MGV) has lost about 1.9% on the year, putting a sizable
difference between itself and PMA. While the lower expense ratio
certainly helps, PMA still crushes MGV in year-to-date terms. A
similar situation is apparent in the iShares Russell Top 200 Index
Fund (IWL) which actually tracks the same index that PMA takes its
securities from. This fund, which charges 20 basis points in fees,
has done better than MGV but is still underperforming PMA, rising
by only 40 basis points so far this year.
AdvisorShares DENT Tactical ETF (DENT)
For investors seeking a global approach, this AdvisorShares
fund, based on the work and managed by Harry S. Dent, Jr., could be
an interesting way to go. The fund seeks to achieve long term
growth of capital by identifying, through proprietary economic and
demographic analysis, the overall trend of the U.S. and global
economies and how consumer spending patterns may change. The
product then takes this information and buys and sells ETFs
accordingly, giving the fund exposure across a number of asset
classes and countries. The portfolio is monitored daily given
market changes and the portfolio can be reallocated at any time
using a sell discipline designed to mitigate risk (read Forget FXI:
Try These Three China ETFs Instead).
Currently, the fund is heavily exposed to both cash and
short-term Treasury bills in the form of TIP. A precious metals
ETF, DBP also receives a good chunk of assets, although this could
change if the economy stabilizes. This strategy has pushed the fund
down about 5.9% since the start of the year and it charges one of
the higher expense ratios in the industry at 1.65%.
While this might sound quite poor, if investors compare this
return to global-focused ETFs such as VSS or VEU, a trend of
outperformance begins to appear. In fact, these two ETFs have lost,
respectively, 16.2% and 11.5%, far outpacing the losses experienced
by investors in DENT. Investors should also note that this is even
taking into account the extremely lower fee levels that VSS and VEU
charge which are about a full percentage point lower than DENT. It
is also important to realize that while DENT participated in the
surge for much of the early part of the year, the fund remained
flat in the summer while its counterparts fell sharply, thanks in
large part to the fund’s sell discipline and movement towards
lower-risk securities (read HDGE: The Active Bear ETF Under The
Microscope).
PowerShares Active U.S. Real Estate Fund
(PSR)
While the American real estate market has been weak and this
fund has seen rough periods of trading on the year, the product has
still managed to beat out its more diversified counterparts. This
is largely thanks to the fund’s methodology which is much like the
aforementioned PMA. With that being said, there are some key
differences that investors should be aware of between the two
methods. First, PSR looks to achieve total return through both
capital and current income investing in securities of companies
that are principally engaged in the U.S. Real Estate industry and
included within the FTSE NAREIT All Equity REITs Index. Securities
are then included based on quantitative and statistical metrics
that identify attractively priced securities and manage risk. This
focus can potentially give the fund a better basket of securities
and the ability to outperform comparable benchmarks (see Top Three
High Yield Real Estate ETFs).
This focus gives the fund a basket of about 56 securities with
the vast majority going towards companies that are structured as
REITs. Simon Property Group (SPG) takes the top spot at just under
11.1% while Ventas (VTR), Equity Residential (EQR), and Vornado
Realty Trust (VNO) all make up at least 5.3% as well. The fund is a
little light on the yield front—paying out 2.9%-- and it has a
relatively high expense ratio of 80 basis points, about seven times
greater than some of the low cost options in the space.
Nevertheless, the fund has risen by about 5.6% so far this year,
pretty good considering the market headwinds that are present.
These gains are even more impressive when compared to some of
the other real estate ETFs in the space, and especially those that
target the broad-based American real estate market. These funds,
such as Vanguard REIT Index ETF (VNQ) and the iShares Dow Jones US
Real Estate ETF (IYR), have both had a rough time in 2011 as VNQ
has risen by just 0.8% and IYR has slid by 1.5% since the beginning
of the year. So although both of these funds charge but a fraction
of PSR’s costs, they have not been able to match up in terms of
performance by any stretch, even when taking into account their
relatively cheap nature from a management fee perspective.
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Author is long XOM.
CONOCOPHILLIPS (COP): Free Stock Analysis Report
CHEVRON CORP (CVX): Free Stock Analysis Report
SIMON PROPERTY (SPG): Free Stock Analysis Report
WAL-MART STORES (WMT): Free Stock Analysis Report
EXXON MOBIL CRP (XOM): Free Stock Analysis Report
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