When shopping for a mutual fund, investors tend to lean toward large, prominent name brands, with savvy and astute fund managers that have generated impressive historical performances. While name branding may be an initial draw, the majority of passively indexed exchange traded funds do not require the level of precognition required of fund managers.
Mutual fund investors want the fund manager that best outperforms a similar benchmark. However, historical evidence has shown that actively seeking to beat the market in the long run does not usually generate profitable returns, compared to passive indexing styles that usually outperform active styles over longer periods. [ETFs Taking Market Share from Index Funds]
Active fund managers have even been labeled as “closet indexers,” charging fees for acting as an active manager while only mimicking a similar benchmark.
Antti Petajisto, former NYU economist and analyst at BlackRock, revealed in a research paper that almost a third of all money in actively managed U.S. mutual funds were run by closet indexers in 2009, reports Bloomberg. [How ETFs Save on Fees and Taxes]
Most ETFs are constructed around a passive indexing style. Basically, the ETF products try to passively mirror the performance of an underlying basket of stocks or securities, for better or for worse.
The only reasons an investor would switch from one ETF investment to a similar ETF product would be to take into account the stylistic construction in the different ETFs, including holdings and sector weightings, along with trade specific details like implicit and explicit costs. [Legg Mason, Fund Firms Mull ETF Entry]
Also, when choosing ETFs, investors want to lean toward funds that are liquid with low spreads and tracking error. It also makes sense to favor ETFs with a comfortable amount of assets under management, usually between $50 million and $100 million, at least.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.