A recent article in Institutional Investor cited Morningstar research that says nearly 63% of U.S. equity funds outperformed their benchmarks during the first five months of the year.
Although long-term data from firms like Standard & Poor’s shows it’s fairly unusual for actively managed funds to outperform broader markets over the longer term, it’s even rarer for them to do so with any consistency. This does not deter proponents of such strategies.
It has been a common refrain of many active managers that their strategies can shine during times of market turmoil because they are allowed the discretion to make decisions about what securities they will hold, but there’s little evidence that this is the case in general.
Inconsistent Results
Given the performance shift that Morningstar noted, it makes sense to take a look at how the performance of some of the largest actively managed ETFs stack up against their passively managed counterparts. While there is some evidence that active management has outperformed passive strategies in the past year, the results are not consistent.
Most actively managed ETFs launched prior to late 2019 when the ETF Rule became effective could not make use of custom baskets, which put them at a disadvantage relative to actively managed mutual funds. And of course, ETFs can’t close to new investments like mutual funds can if their assets grow too large and unwieldy for their targeted strategy.
The ETFs mentioned in the following discussion are selected based on their size and the nature of their portfolios; all are equities funds.
Given the fact that actively managed ETFs have traditionally dealt with more requirements than actively managed mutual funds, it’s not surprising that there are not many examples of continued or significant outperformance. However, sustained outperformance is also extremely elusive when it comes to active management in a mutual fund wrapper.
Looking at different ETF families across equity asset classes, it seems there is a definite possibility of achieving outperformance, but the question is whether it’s worth it. Actively managed ETFs generally have higher expense ratios. For example, ARKK comes with an expense ratio of 0.75% versus 0.32% for ACWI, though that’s an extreme example. DWLD comes with an expense ratio of 0.62%, which is 30 basis points more expensive than ACWI. However, the Vanguard factor ETFs, with one exception, are cheaper than their passive counterparts, which is another point in their favor.
The other potential drawback of actively managed ETFs is the fact that, once a manager has discretion to select securities, the end user may not fully grasp the risks that can be introduced with each decision unless they are closely monitoring the portfolio. Further, managers can change, and it’s not clear that a proven manager will be replaced with a similarly skilled professional.
Investors may want to decide whether the periodic outperformance that can come with active management is worth the generally higher prices and the risk of underperformance.
ARKK
The ARK Innovation ETF (ARKK) seems like a good place to start, as it has been in the spotlight for years. An actively managed and fully transparent ETF, it holds high-conviction positions in companies exhibiting disruptive innovation in their respective industries. ARK pulled in massive assets after it outperformed the broader market during certain calendar years, such as when it notched a return of more than 150% in 2020. However, in 2021 it trailed the S&P 500 dramatically and has continued to do so in 2022. Despite this, it has seen $6.5 billion in inflows since the start of 2021.
Year to date as of July 5, ARKK is down nearly 50%, while the global iShares MSCI ACWI ETF (ACWI) is down a little more than 17% during the same period. Over the 12-month period, the difference is even more stark, with ARKK down 60% and VTI down a little less than 10%. And three-year annualized returns indicate ARKK was up less than 1% while VTI was up 11%.
However, if you look at more recent performance such as the month ended July 20, which was a fairly volatile period, ARK has pulled ahead, with a return of 24% versus ACWI’s return of 5.44%. So it’s possible ARKK could demonstrate sustained outperformance if the recent trend continues, but that remains to be seen.
Dimensional Fund Advisors
Dimensional, which is a fairly new entrant to the ETF space, having launched its first funds in 2020, is known for its broad-based active strategies that tilt toward companies exhibiting smaller size, value and profitability characteristics.
The $2.2 billion Dimensional U.S. Core Equity Market ETF (DFAU) notched a loss of 15.55% year to date through July 20, which beats the cap-weighted $247.4 billion Vanguard Total Stock Market ETF (VTI) return of -17.36%. Over the 12-month period, DFAU outperformed, with a 7% decline, while VTI was down nearly 10%. DFAU continued to outperform over the more recent three-month period, with a return of -10.74 versus -11.16% for VTI. However, over the one-month period, DFAU trailed VTI’s 8.27% return, with a 7.94% return
If you consider the $4 billion Dimensional U.S. Small Cap ETF (DFAS) when compared with the iShares Russell 2000 ETF (IWM), there’s some noticeable outperformance, with the former notching a 12-month return of -6.29% versus nearly -16% for the latter. Year to date, the gap closed a bit more, with a loss of nearly 15% for DFAS versus roughly 18% for IWM. For the three-and one-month periods, about 1% separates the returns for DFAS and IWM, with DFAS’ edge still holding.
Further, if you pit the $1.2 billion Dimensional Emerging Core Equity Market ETF (DFAE), which rolled out in December 2020, against the iShares MSCI Emerging Markets ETF (EEM), you see that same reversal. Over the one-year and year-to-date periods, DFAE had returns of -18.76% and -16.34%, respectively, while EEM returned -23.74% and -18.71%.
However, a look at the more recent three-and one-month time periods shows that DFAE trails EEM for both periods. The former is down 1.25% for the month ended July 20 and 10.64% for the three months, while EEM is down just 0.76% and less than 9% for those same respective periods.
Davis Advisors
Davis launched its first funds in early 2017, so it’s built up a bit of a track record. The firm constructs value-oriented portfolios that rely on stock picking to develop fairly concentrated, high-conviction portfolios. The $315 million Davis Select U.S. Equity ETF (DUSA) is the firm’s flagship fund, with a portfolio of just 27 holdings.
It has a bit of a mixed track record relative to the broader U.S. market, trailing VTI during the three-year annualized period, with a return of 7.61% versus VTI’s 11% return. And during the last 12 months, it returned -16.87% versus a -9.94% return for VTI. The gap closes during the year-to-date period, when VTI lost 17.36% versus a 16.09% decline for DUSA. It tightens further for the three-month period, with DUSA and VTI both falling roughly 11%. Again, there’s been a reversal over the past one-month period, where VTI gained 8.27% versus a gain of 5.75% for DUSA.
The $264 million Davis Select Worldwide ETF (DWLD) selects its holdings at a global level and currently has a portfolio of 36 companies. Over the past three years, its performance has been spotty compared to ACWI. Over the three-year annualized period, it gained 7.13% to ACWI’s 3.32%, then saw even greater underperformance during the year-to-date period, falling 22.9% versus ACWI’s 12.35% decline. However, year to date, DWLD is down about 15%, while ACWI is down 17.55%, and during the 3three-month period, the Davis fund is down just 6.11% to ACWI’s 11% decline. DWLD trails ACWI during the one-month period too, with a 4.71% increase compared with a 5.44% increase for the latter fund.
Vanguard
The Vanguard Factor ETFs are perhaps the most overlooked funds in this discussion. Roughly two years after their launch, I wrote an article about how they were almost all underperforming their index-based counterparts, largely due to an excess of value exposure, but that trend has shifted. In fact, the Vanguard factor ETFs were the most likely to outperform during the periods examined here. We look at the largest funds in that grouping for the sake of comparison.
The largest is the $694 million Vanguard U.S. Value Factor ETF (VFVA), which is comparable to the $9.1 billion iShares MSCI USA Value Factor ETF (VLUE). The former outperforms the latter over the three-, one-and year-to-date periods. VFVA was up 12.59% during the three-year annualized period, up 2.76% during the one-year period and down 7.16% during the year-to-date period, while VLUE returned 7.35%, -5.63% and -12.85%, respectively.
However, the gap narrowed for the three-month period with a return of -10.82% for VFVA versus -10.45% for VLUE. Then, during the one-month period, VFVA returned 6.33% to VLUE’s 6.44%.
The $200 million Vanguard U.S. Momentum Factor ETF (VFMO) also exhibits fairly strong performance relative to the $10.2 billion iShares MSCI USA Momentum Factor ETF (MTUM). Over the three-year annualized period, VFMO was up 10.59% while MTUM was up 5.25%.
As the market fell into a decline, VFMO fell 11.22% during the 12-month period, versus a decline of nearly 19% for MTUM, with the trend continuing into the year-to-date and three-month period, during which VFMO fell 16.4% and nearly 13%, respectively, while MTUM fell nearly 24% and 14.78%.
Tables source: FactSet and Bloomberg, data as of 7/20/2022
Contact Heather Bell at heather.bell@etf.com
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