While observing the discussion around ETFs, especially in Europe, I become a bit concerned that the critiques are getting too tired—pundits seem to be going over the same topics again and again. In some cases the arguments have been proven wrong or are the result of the nature of the investment products. To give an example, some critics—mainly from the active management industry—raising the point that ETFs are always fully invested and don’t do active asset allocation, which leads to losses if the underlying index declines. Well, that’s obviously right, but I can’t see an issue here. Investors want their ETFs to track the underlying index as closely as possible. To be explicit, it is the aim of an ETF to replicate the risk/return profile of its underlying index as exactly as possible in all market circumstances. This means the ETF and therefore the investor will face losses when the market goes down—a fact any ETF investor should be aware of prior to his decision to buy an ETF.
But the discussion goes further; the critics say these losses are possibly higher than for actively managed funds, since active products can hold cash or move in sectors that are more defensive in order to protect investors. That is a valid point, but the past has shown that the average active manager has not always been able to do this. A high number of funds, even in standard asset classes such as global equity, lost more than the market indices during the “tech-bubble” burst (2001–2003) as well as during the “financial crisis” (2008–2009).
With regard to the success of ETFs globally, I can understand why active managers are discussing in public possible issues that might arise for investors when they use ETFs. But, with regard to the results that have been delivered by the average active fund manager over the last 20 years, I can understand why investors have started to use ETFs. That said, from my point of view active managers need to start to prove the academics and performance comparisons wrong by delivering exceptional outperformance, instead of moaning about possible risks and issues coming from their (at least at the moment) more successful competitors.
The views expressed are the views of the author, not necessarily those of Thomson Reuters.