When picking an actively managed fund, people are betting on the fund manager’s ability to produce alpha, or outperformance. However, investors may be better served in a passive index-based exchange traded fund in the current environment.
Cheap, traditional beta-index ETFs have outperformed most actively managed funds so far this year, reports Brendan Conway for Barron’s.
At the beginning of the year, investors assumed that the improving market conditions would be an ideal set up for stock pickers and active managers as market correlations and the herd mentality begin to diminish. [Poor SPIVA Scorecard Highlights Appeal of Index ETFs]
However, as of o the midyear, 73% of large-cap fund managers have underperformed indices, according to Morningstar data. Active managers produced an average 5.8% this year, whereas the widely observed SPDR S&P 500 ETF (NYSEArca: SPY), which passively tracks the benchmark S&P 500 Index, rose 7.1%. If the trend continues, this year could turn out to be the worst showing for active funds in the last decade, compared to the benchmark index.
While stocks are moving less in line with one other, there have not been many runaway opportunities. Managers rely on individual stocks to outperform and diverge from the average benchmark returns.
Neil Leeson, ETF strategist at Ned Davis Research, recently measured the tendency, argues that the stock-selection menu has been sparse. Of the S&P 500 stocks that have advanced or trailed the index by 5% over the past three months through mid-July, only a little over 50% of the constituents have moved beyond the 10 percentage point range.
In contrast, the historical average for this dispersion level is 66%. According to S&P Dow Jones Indices, the dispersion is at or near all-time lows.
“With so little variation, it’s just plain difficult to make good picks,” Leeson said in the article. “You can’t tilt a portfolio the way you used to.”
However, stock pickers may notice that biotech stocks show some unusually high dispersion levels. A number of smaller companies have generated breakthrough drugs, which has helped the SPDR S&P Biotech ETF (NYSEArca: XBI), an ETF based on an equally weighted index, outperform the market-cap weighted iShares Nasdaq Biotechnology ETF (NasdaqGM: IBB). Year-to-date, XBI is up 13.2% and IBB is up 12.1%. [Puma Pumps up Biotech ETFs]
For more information on passive ETFs, visit our indexing category.
Max Chen contributed to this article.