ETFs vs. Active Managers

March 8th at 2:00pm by Tom Lydon

Overall, fund managers are beating stock market benchmarks much more than they did one year ago, according to Morningstar data. However, some evidence suggests that exchange traded fund portfolios can provide investors with the same market factors, minus the management fees.

“Managers are adaptive, but they don’t change their stripes all that often,”Aaron Reynolds, associate director of asset-manager research at Robert W. Baird & Co., said in a recent report. Instead, market dynamics are always changing, said Reynolds, which results in a cycle where a percentage of active managers are beating benchmark movements. [PIMCO ETF Puts Focus on Active ETFs]

The cyclical nature of active manager outperformance has laid the groundwork for the argument of active versus passive investing, reports Karen Damato for The WSJ. John Cochrane, finance professor at the University of Chicago Booth School of Business, says investors are misguided if they think fund managers add or subtract value to a portfolio based on how well they pick individual stocks.

In general, managers have a strategy that favors certain kinds of stocks and those shares with a common thread all rise and fall together, explains Cochrane. The performance of a fund versus a benchmark can be judged better by a manager over or under weighting. [Active VS. Passive ETFs]

An alternative to figuring out the rise and fall of an active managers cycle is to construct a portfolio of ETFs, which ultimately provide exposure to the same market factors. ETFs cover different sectors, dividends, asset classes and low volatility, and they have lower expense ratios than active management fees. [Active ETFs Seen Taking Off in 2012]

Basically, ETFs have “raised the bar” for active managers to show their prowess. While there are active funds that beat benchmarks from time to time, investors should be cautious about funds that have recently outperformed a benchmark.

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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