The author compares risk-adjusted return measures of actively managed exchange-traded funds (ETFs) and similar but passively managed ETFs over different time periods from 2010 to 2012. The results show that actively managed ETFs do not significantly outperform passively managed ETFs with similar strategies on a risk-adjusted return basis. The author also finds that active ETFs with higher trading volumes outperform active ETFs with lower trading volumes.
The author begins with a brief history of exchange-traded funds (ETFs). The first ETF was a Standard & Poor’s Depositary Receipt (SPDR), launched in January 1993. The SPDR’s strategy is to mirror the returns of the S&P 500 Index, and it currently has a market value of more than $125 billion. The ETF market has grown steadily since 1993 and now includes approximately 15% of all managed assets. The author believes ETFs are relatively attractive to investors because, among other factors, they trade on an exchange, have more transparency regarding holdings, and typically trade at a price near the fund’s net asset value.
ETFs have historically been focused on index strategies, but since 2008, some fund managers have been offering actively managed ETFs. According to the author, there were 39 actively managed ETFs at the end of 2011, with a total of $5 billion in assets under management. In 2012, there were 54 actively managed ETFs, with a total of $10 billion in assets under management. The author’s research focuses on the risk-adjusted performance history of actively managed ETFs compared with that of passively managed ETFs with a similar investment strategy.
The author finds that actively managed ETFs have higher volatility and tracking error than their passive counterparts but do not offer significantly different returns. He concludes that active ETFs underperform similar passive ETFs on a risk-adjusted basis (i.e., using the Sharpe ratio). This result is true for both equity and debt ETFs and for ETFs with both low and high expense ratios. The author also finds that active ETFs with higher trading volumes have higher risk-adjusted returns than active ETFs with lower trading volumes.
How Is This Research Useful to Practitioners?
The results show that the actively managed ETFs in the study do not outperform similar index-based ETFs from a strict risk-and-return perspective. The author notes that actively managed ETFs may be valuable as lower-cost diversification options for existing portfolios. This information would be useful for financial advisers, wealth managers, and investors in general.
How Did the Author Conduct This Research?
The author analyzes 20 actively managed ETFs for the period of January 2010–December 2012. Ten of the active ETFs are equity funds, and ten are debt funds. The funds all have a performance history of more than six months. Returns for these funds are computed for various time periods, including three months, one year, and three years. These returns are then compared with the returns of passively managed ETFs with similar investment strategies for the same return periods. In addition to segmenting the active ETFs into equity funds and debt funds, the author separates them by trading volume and expense ratio.
This research is performed over a short time frame for a limited number of funds. Hopefully, the author will continue to track the returns of these actively managed ETFs over longer time horizons. It would also be valuable to see research on the returns of new actively managed ETFs as those funds accumulate return data. Further research also appears necessary to learn more about why active ETFs with higher trading volumes outperform active ETFs with lower trading volumes on a risk-adjusted basis.