Beat the market without even trying

New research shows that actively managed ETFs don’t beat the market, but passive ETFs can.



From the June 2011 issue of the magazine.



Only a few years ago, the term “actively managed ETF” was an oxymoron. When exchange-traded funds first appeared, they simply tracked well-known stock indexes and made no attempt to beat the market.

Today there are dozens of actively managed ETFs, and they seem to offer a lot of promise: with lower costs and better tax-efficiency than mutual funds, ETFs with active managers should have a greater chance of earning above-market returns.

However, Greek researcher Gerasimos Rompotis has just published a pair of studies that turn that idea on its head. He found that once you adjusted for risk and other factors, it was the traditional passive ETFs with no money manager that outperformed.

In one recent paper, Rompotis examined the performance of 14 actively managed ETFs using three statistical methods to see whether the managers delivered “alpha,” or a risk-adjusted “premium” that beat the S&P 500. Some of the ETFs did outperform the index slightly, but the alpha was statistically insignificant, so it wasn’t likely to last.

On the other hand, an earlier study by Rompotis found that most passively managed ETFs have outperformed the S&P 500 when he ran them through similar tests. His results covered a five-year period and suggested that the outperformance wasn’t a short-term fluke.

How is that possible? It’s because most of the individual ETFs in the study did not use the S&P 500 as their benchmark, Rompotis stresses. So the funds may have been able to deliver better risk-adjusted returns simply by tracking different indexes, without active management. “Even though investors follow a passive investing strategy,” Rompotis wrote, “they still stand chances of achieving greater returns than the market.”

One comment on “Beat the market without even trying

  1. Hello, your website and magazine have done a great job exposing the benefits of ETFs. Is it possible to produce an article that talks about the tax basics related to ETFs? I know that is not going to be easy given the short history of ETFs, but the one reason I have been holding off on ETF investing is because I don't understand the tax implicaitons. This especially applies to dividend bearing ETFs.



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