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iShares Missing The Point

Active management has existed for a few years in the ETF world but—and this has been one of the loudest criticisms of it—the holdings of the funds have always been transparent to investors. iShares itself won the right to market such transparent active ETFs from regulators in March.

The reservations people have had with transparent active ETFs center on the fact that outsiders could know what the fund was holding and game their strategies, hurting ETF shareholders.

That’s what makes iShares’ new filing important news. But transparent or not, iShares’ new initiative to open a whole new marketing front in the world of ETFs misses the point.

The push into black-box active strategies is a mistake, and the reason is simple:The success of ETFs is largely because they put portfolio allocation decisions into the hands of investors. ETFs opened up easy access to a broad palette of investments—from global stocks to junk bonds to commodities futures contracts—but they left the tiller in the hand of the end investor.

Most importantly though, ETFs have largely championed the use of indexes, which have generally outperformed active managers over the long haul, according to the Standard & Poor’s Indices Versus Active Scorecard. Moreover, actively managed funds tend to cost more to run, so active funds have typically been a pay-more-for-less proposition.

ETFs are rooted in index investing, with the U.S. ETF industry getting its start with the 1993 launch of the SPDR S&P 500 ETF (NYSEArca:SPY). Passive, index-based ETFs were the only flavor of ETFs for the first 15 years of the industry. It was only when most of the obvious indexes had been used that issuers turned their attention to active ETFs, with the first actively managed fund launching in 2008.

Active ETFs have had some trouble taking off. Aside from a few successes, active ETFs just haven’t done very well. As a whole they are dwarfed in popularity by passive funds. Our in-house data shows that active ETFs assets make up just $6 billion, or 0.6 percent, of total ETF assets, or about $1.055 trillion.

Currently, there are only about 40 active funds on the market, so there is the potential that the right active ETFs just haven’t been marketed yet. And I have no doubt that that’s the growth potential iShares is eyeing with its latest filing.

But the truth is that ETF investors are probably better off staying largely in passive funds. ETFs have proven to be a great tool to make diversified plays on the market. But their real benefit has been placing power in the hands of the end investor.

ETFs have so far done a good job avoiding the performance-chasing behavior more common among mutual fund and hedge fund investors, precisely because ETF investors had to make allocation decisions themselves.

It would be nice to see ETF investors stay away from chasing alpha, when it’s clear that the odds are against them, and instead let their own sober analysis guide them to reasonable investments.

Don't forget to check IndexUniverse.com's ETF Data section.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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