THE exchange-traded funds (ETF) industry has the enemy in its sights: It’s the active manager, who runs a traditional equity mutual fund. When they first appeared in the marketplace, ETFs talked up such virtues as their lower costs, tax advantages and how easy they were to trade. Now, after the worst year for the Dow Jones Industrial Average since 1931, they’re going in for the kill.
“Active managers say they’ll protect you when the market falls by getting ahead of it,” says Lee Kranefuss, chief executive officer of Barclays Global Investors’ iShares business. “That promise is hard to deliver on.” ETFs are not only cheaper, he says, they outperform the managers, too. An ETF is a mutual fund that you buy and sell through a brokerage account, such as an individual stock. Most ETFs are index funds — meaning they track the performance of a particular market, or slice of the market, rather than try to exceed it.
In theory, active managers should beat indices because their funds can build up cash during a market drop. They’re also supposed to be able to pick the stocks that will hold up better during declines. That’s one of the things you pay them for.
They’re not earning their pay. Last year, 58 per cent of all actively managed funds lost more in value than the benchmark they measure themselves against, according to Morningstar. That’s not much better than chance. Small-cap managers, who are supposed to be especially nimble, had a particularly bad year — 72 per cent of them fell behind their benchmarks.
The numbers get worse when you compare the managers’ performance with the Standard & Poor’s 500 Index. Among largecap US funds, 62 per cent lagged behind the S&P in 2008, as did 63 per cent of all US diversified equity funds. Most managed funds trailed the indices in the first phase of a recovery, too. As an example, look at what happened in the 12 months starting in October 2002, the bottom of the last bear market. Seventy-eight per cent of US managed equity funds did worse than the benchmark they measured themselves against. You are paying your managers to miss.
Investors are catching on. They pulled $128.7 billion out of managed equity mutual funds in the first 11 months of 2008, according to the Investment Company Institute in Washi-ngton.
