Do Active ETFs Outperform?

By Grant Engelbart, CLS Investments

As I suggested in a previous post, active mutual fund managers, in aggregate, do show some ability to outperform — gross of fees — and if these same managers moved to ETFs and lowered their fees, they would improve their outperformance odds. While active ETFs are relatively new and limited in size and scope, we can still draw from the experience thus far to get a sense of how managers have performed in the ETF structure.

From the already-limited universe of active options, I excluded funds launched within a year to get a somewhat fairer comparison. I then looked at each fund’s performance versus its stated prospectus benchmark and Morningstar-assigned category index (this is not the category average, but a standard index used to measure performance of funds in the category). That left us with a measly 142 ETFs.

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How do they do? In aggregate: “Meh.” Only 30% have beat their benchmark return since inception, and just under 40% have beat their category average since inception. Funds that have outperformed have done so by an average of around 2%, but those that underperformed have lost by nearly 3%. The results by broad category are shown below. Taxable bond, sector equity, and commodities have fared best. Commodities should have an asterisk as only five funds are included in this category (number of ETFs shown below the graph).

Source: Morningstar. Fund and Index performance is from the listed inception date of the ETF. Active ETFs used have at least 1 year of live performance history.

The environment over the last few years hasn’t been all that friendly to active managers, and these results aren’t all that great either. As mentioned in my previous post, “Getting Active in 2018,” much of the problem is fees. After all, ETFs are mutual funds, so we shouldn’t expect some magical benefit from active managers converting to the ETF structure if they choose to leave their fees high.

But wait! If we divide the universe by fee, the picture improves. I separated out active ETFs with at least a year of history into five buckets. Today at least, there are only seven active ETFs with gross expense ratios under 0.3%, but their performance has been solid since inception. These happen to all be short-term bond ETFs. The next bucket — funds with expenses between 0.3% and 0.6% — performs relatively well, with over half the ETFs outperforming both benchmarks. Not surprisingly, outperformance percentages generally decline as funds get more expensive. There are 56 ETFs (40% of my universe) with expenses above 0.9%!