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Actively Managed ETFs Outperform Passive Ones in Turbulent Market: Here's Why

Historically ETFs or exchange-traded funds have been on the rise since the 00s with the US taking the lead as ETFs represent 12.6% of their total equity whereas it’s 7.5% for Europe and 3.9% for Asia-Pacific. Broad index ETFs such as the S&P500 and FTSY100 became very popular with institutional and retail investors alike due to their high diversity and relatively good returns. As stocks and bonds suffer huge losses in the face of high inflation, rising rates, energy shocks and geopolitical conflict, however, investors look for alternative methods to diversify their portfolio rather than just investing in a passive index fund.

Not a good year for ETFs

As global ETF inflows fall by 32.8% (from $1.29tn to $867bn us dollars) we see a significant difference between the inflows of the two largest ETF providers - Vanguard and BlackRock. Vanguard’s inflows fell by 39.7% whereas BlackRock’s iShares fell by only 28.3%. This difference could be attributed to the fact that iShares have a bigger variety of ETFs compared to Vanguard who only offers the core ETFs and had a big stake in the S&P500 and FTSY100 indexes that tanked in 2022. This, however, is nothing compared to SSGA and Invesco whose inflows fell by 71.9% and 55.7% respectively due to low interest in the growth-oriented SPY and QQQ (Nasdaq100). A lot of focus had been put on their flagship ETFs and the result of that is the bigger reduction in inflows. QQQ specifically is 8 times bigger than Invesco’s second-largest ETF.

Actively managed ETFs on the rise

Actively managed ETFs represent only 5% of total ETF assets in the US yet accounted for 12% of the inflows. Moreover, newly launched ETFs have 60/40 split between active and passive ones showing a growing interest in the active approach.Rising rates of inflation and the underperformance of broad index funds have made active ETFs an attractive investment as having and experienced asset manager is important when markets are unpredictable. In fact, one of the most popular actively managed exchange-traded funds, ARKK is up 30% since January. JPMorgan also saw a growth of 24.6% in their ETF assets from the increased demands for active ETFs but also due to converting a part of their mutual funds into ETFs. Actively managed exchange-traded funds are traded on a daily basis and are required to disclose their holdings, this means that managers could respond to unexpected circumstances, minimising losses or even making profit. On the other hand this service does come with a higher fee compared to the passive ETFs, however, it also gives more security during economic uncertainty when people are more concerned about minimising losses rather than trying to make a profit.

A big number of new ETFs but no money

Number of ETFs in the world

ETFs as a whole have seen a rapid increase in the last two decades as thematic ETFs focusing on niche sectors (such as Marijuana ETFs) have become a popular way of making money quickly. This popularity has led to the creation of ETFs tracking a certain month’s new trend but the result of investing in these types of assets often ends up a loss in the portfolio as the period of initial interest and growth in the sector has probably ended by the time these financial products have been rolled out. Additionally, investors may get emotionally attached to their investment because the idea might sound cool (e.g., Cathie Wood’s Innovation fund). This large inflow of new ETFs has also made the competition fiercer, driving down fees but that has also made it harder for smaller companies to compete with giants like Vanguard who constantly slash their prices. Another factor to be considered is that the development of ETF assets has decreased from 2021 to 2022 which may indicate a need to reconsider investing in traditional exchange-traded funds at least until the economic issues in the world become more stable.

ETF asset development

Dangers of investing in ETFs in the current market situation

ETFs taking an active approach or ones whose strategy is more defensive or income generating focused have had better returns due to the volatility in the market. The best performing ETFs for 2022 are mostly related to oil and energy. However, it is unknown whether this trend will continue into 2023. Energy markets aren’t necessarily a good choice to go forward with as looking at performance for individual years isn’t a reliable way of predicting trends for the next year. In many ways this year’s market conditions will be different. The initial shock from Russia’s invasion has been overcome but tensions are still high and the situation is yet to be resolved. China, on the other hand, is finally starting to open to the world as zero-Covid restrictions are being reduced. Investors have also pulled $10bn out of US ETFs and invested $12.7bn into international equity during January, this being the biggest outflow since January 2019.

What ETFs are considered a good investment now?

Statistically, passive broad index funds give the best result over time compared to other options, but that is considering the investor decides to buy and hold a certain ETF without doing anything else. There is still economic turmoil in the world and the danger of recession is still looming over. Even professionals are struggling to make any kind of profit let alone retail investors. A good approach for the short term could be investing in an ETF with a more defensive approach and lower risk or an active one where a professional asset manager can look over the portfolio and make sure that there is no exposure arising difficult circumstances. Bull runs account for most of gains in the stock market so unless an investor is confident in their choice it makes less sense to participate in riskier investments during unfavourable conditions.

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