The explosion of ETFs onto the financial market scene has been nothing short of phenomenal, and some analysts are seeing signs of an implosion. Despite this, active managers are still failing to seize back the spotlight, according to an article by the Financial Times
In the broad market case, increased ETF activity should create more bargains, which would result in choice stocks being ripe for active managers’ picking. In addition, Donald Trump’s recent election win has created ideal conditions for active managers to outshine indexers: index-tracking by S&P shows that stock correlations have decreased, and S&P’s Spiva service found extremely high-level dispersion of returns in November.
“But volatility remained low, which should lead to an increase in idiosyncratic (as opposed to broader macroeconomic or market) risks for individual stocks,” the article read. “Deflationary stocks — high-yielders and defensive names — were out, while inflationary names, such as cyclicals and financials, were suddenly in.”
Despite the opportune conditions, active managers were unable to capitalize. In the two weeks after the election, 54% of the US active equity mutual funds tracked by Barclays underperformed their benchmarks. Separating the top and bottom deciles was a 4-percentage-point gap.
While active funds have picked up a lot since mid-2016’s market turn, they are lagging for the year because they positioned themselves too early for the late-year turnaround. “Goldman Sachs finds that slightly more than half of US large-cap managers have beaten their benchmarks since the end of June, but only 23% have done so since the beginning of the year,” the report said. “They were far too heavily weighted in cyclicals and inflationary stocks from the year’s outset, and are still a long way behind.”
ETFs, on the other hand, have managed to succeed because of their suitability to short-term sectoral bets. “According to Barclays’ US equity strategist Keith Parker, inflows into ETFs tracking US industrials were equivalent to 20% of their market value, in just the one week after the election alone,” said the report.
Further hampering active managers was the continuing redemptions from their funds, forcing them to sell and not realize the gains they could have from the market rally fueled by ETF money.
“If this sectoral rotation continues — which it should unless the Trump administration radically fails to put its agenda into action — then active managers might in aggregate find themselves topping the indices next year,” the article read. “But they will have done so by holding on to the coat-tails of ETFs and making their distortions even worse, and not by correcting them.”
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