Owning an equity fund brings a certain satisfaction. Each day, countless individuals rise early, commute, and dedicate themselves to securing clients, optimizing supply chains, and developing software—all of which contribute to corporate profits.
These earnings ultimately benefit me, even when I might be relaxing at home. Shareholders enjoy a portion of the rewards without having to sit through endless virtual meetings.
I extend my gratitude to all those employed by the 1,245 companies within my investment portfolio. Your hard work has already added £17,000 to its value this year, and I hope it has positively impacted your finances as well!
This reinforces my preference for stocks over government bonds. I have far greater confidence in the 140 million workers of publicly traded companies than in those tasked with tax collection.
However, it’s important to note the significant variance in quality among the many firms represented in my exchange-traded funds (ETFs). Consequently, returns also vary. This is a key argument for the existence of active fund managers.
Identifying winning stocks before they excel is undeniably challenging, and past performance is often inconsistent. Likewise, underperforming stocks don’t remain stagnant indefinitely.
Stock pickers argue that it is easier to recognize losing investments. Even if they overlook top performers like Nvidia or Tesla, they can still achieve relative gains by excluding these losers from an index.
When I first encountered the rise of active exchange-traded funds, I assumed they provided a method for filtering out underperformers—something I previously referred to as benchmark optimization or tilting.
I envisioned index trackers that excluded poor performers using automated filters such as declining revenues, low profit margins, or high debt levels. However, active ETFs feature genuine stock pickers seeking long-term investment growth.
Many are aware that most active funds tend to underperform their benchmarks, and active ETFs are likely no different.
Are real analysts and portfolio managers behind my ETF’s value growth, as opposed to simply outperforming an index? Indeed. But there’s even more to consider.
Unlike traditional mutual funds, which have limited daily pricing and high fees, active ETFs can be traded on exchanges like stocks and typically charge about a third of the price. This sounds appealing, right?
To explore this further, I used Excel to analyze the holdings and their weights of the new iShares World Equity Enhanced ETF, alongside its passive counterpart, the iShares Core MSCI World ETF. Both funds benchmark against the MSCI World index, but the Core fund aims to track it, while the active ETF focuses on growing investments.
I also compared their total expense ratios. The standard ETF charges 0.2% annually, whereas the active version charges 0.3%. At first glance, the latter might seem like a good deal.
The idea of active management and potentially higher returns for just a slight increase in cost appears to be enticing. Additionally, active ETFs allow for more flexible trading.
However, the reality is that active ETFs are unlikely to yield greater returns on average. They appear designed to gradually phase out traditional active funds, which typically charge higher fees.
To clarify further, most active funds underperform benchmarks, a fact well-known in the investment community. Active ETFs will follow suit, making it more sensible to opt for the lower-cost option.
Investors who endorse market efficiency will continue opting for the cheapest passive ETFs. However, some undecided investors might be lured in by the prospect of minimal additional costs associated with active funds.
Taking a closer look at the two iShares funds, the active ETF comprises over 400 holdings. Ironically, this is the approximate number needed to ensure one does not underperform an index, which essentially makes it passive in nature.
Both the active and Core ETFs share the same top nine holdings, listed in identical order, differing only slightly based on timing. Surprisingly, none of the active fund’s allocations deviate by more than 0.6% from those in the passive fund.
In fact, the active portfolio’s most aggressive bets consist of two positions slightly overweight by 0.63%. For instance, moving Bank of America from the 23rd spot in the Core fund to the 10th, or ABB from 141st to 121st, signifies a risk increase of no real consequence.
What about the underperforming companies that active fund managers should ideally avoid? The largest underweight position in the active ETF is Berkshire Hathaway, with a -0.55% adjustment compared to the Core fund, though it still holds 0.3% of the stock.
The next two underweights, Visa and Exxon Mobil, are even less pronounced but are not excluded entirely.
Proponents of active ETFs argue this mirrors risk reduction. Nonetheless, it does not extend to a level where these funds deviate significantly from being index trackers, nor do active managers consistently outperform the index even with additional risk.
Ultimately, active ETFs serve as a vehicle for raising fee structures. Similar to choosing between carbonated and still water at different price points, many investors may wonder, “Why not go for the active option?”
photo credit: www.ft.com
