Key Points
- Active funds struggle to find relevance as investors increasingly realise there is little point to them.
- ESG ETFs under scrutiny by the FCA for not actually being ESG focussed.
- Crypto-mania revived as Bitcoin ETFs expected to be approved by US regulator.
- ETFs offer a risk-conscious way of getting a piece of the AI megatrend without picking a winner.
The Emperors of Investing Have No Clothes
Analysis by Bloomberg questions the continued relevance of active fund management in a world of low-cost index ETFs:
Many ordinary people do not want to think about their investments much, and modern finance has designed a product that is ideally suited for them. It is the index fund (or index exchange-traded fund), whose essential thesis is that thinking about investments is unnecessary and in fact bad, and you should just buy the market and save on costs.
Silla Brush and Loukia Gyftopoulou look at the plight of some of the world’s largest mutual funds, with billions flowing towards the exits in search of low-cost, passive funds.
The whole industry of active mutual fund management is built on the idea that, if you don’t want to manage your investments, you can pay someone else to do it for you. But that idea feels passé in 2023. These days, if you don’t want to manage your investments, the accepted approach is to pay someone else almost nothing to almost not manage them for you: An index fund will do almost no managing and charge almost no fees, and that is widely considered the optimal approach.
Add to this the reality of consistently poor returns over the long term for active managers, and the dwindling case for active funds looks even more dire.
As we’ve covered previously, SPIVA scorecards make this futility clear. Over 1, 3, and 5 year periods, some 70-90% of active funds across regions underperform basic index benchmarks. Over 20 years in the US, more than 80% trail the S&P 500. Study after study confirms most managers cannot overcome the headwinds of costs, taxes, and simple chance to beat the market.
Still, SPIVA “persistence” research shows short streaks of outperformance are possible. Around half of 1-year beaters extend their edge the next year. But by year 3, virtually none maintain their edge. This fleeting “alpha” may tempt investors to trade in and out of hot funds. However, the costs and tax headaches of flipping funds makes this gamble even more dubious.
In the UK, it was recently reported that 80% of active funds lagged the FTSE over the last 3 years.
The industry also sows constant doubt that passive can work forever. Now, they argue, with higher volatility, skilled managers will show their value. But each downturn was supposed to be their time to shine. We’re still waiting.
ESG ETFs – Some are a bit light on the E, S and G.
Reuters reports on the FCA’s moves to clean up the quagmire of nonsense in the ESG space.
“We have seen some passive funds with ESG related names that are actually just passive funds, they are just replicating normal indexes that don’t have a ESG focus, which we deem to be completely misleading and something we have been pushing back on.
We’ve also seen some funds come through where the fund’s proposed holdings differ very much from the objectives and the statements that they are holding our to be true.”
New ESG labelling rules are coming, and are expected to be quite a tricky ask for a lot of ESG ETFs. The whole ESG ratings and labelling industry is a mess. Here at twoETFs we are working on an in-depth look at ESG ETFs and how to invest sustainably, so watch this space.
Bitcoin ETFs incoming
Crypto-fanciers are thoroughly aroused by the expected SEC approval of Bitcoin ETFs. The oldest of the cryptocurrencies is recovering from the collapse of the Terra stablecoin and the ongoing Sam Bankman-Fried circus, recently hitting a 17-month high.
Big swingers like Blackrock have submitted filings with the SEC indicating they would like to play in this particular sandpit. Some argue that major institution involvement would limit the influence of unregulated players in the sector. And yet, the SEC has previously said that it can’t guarantee the Bitcoin market will not be prone to manipulation.
Proceed with caution.
Spreading your AI risk
The FT considers an important aspect of investing in AI, applicable to all young, hot investment trends that on the surface can look a bit bubbly. In any industry evolving at a rapid rate of knots, picking the company that will eventually come out on top is a fools errand.
“We are still in the process of discovering what AI users will demand, how to price it, and the revenues and profits that will be earned via AI,” says Christopher Gannatti, head of research at WisdomTree. “Some of the future winners from the AI megatrend will be surprises, which makes it important to have a diversified investment strategy.”
The beauty of an AI-focussed ETF, as with index ETFs in general, is that you can spread the risk across the industry. For more on this, see our recently published guide to AI ETFs.
