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Zombie active funds to walk again

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Michael Mell, Director for Custom Indices, S&P Dow Jones Indices writes that active management is still losing out to passive index management, despite the proliferation of active funds each year. 

Drawing an analogy with AMC’s Zombie series ‘The Walking Dead’, Mell compares active funds with the walker zombies in Rick Grimes’s post-apocalyptic world.  
 
Mell writes that according to the 2015 year end SPIVA Europe Scorecard, which measures the performance of actively managed funds against their benchmarks, 84 per cent of US active funds underperformed the S&P 500 and an astounding 98 per cent of US active funds trailed their benchmark over the past ten years.
 
“Interestingly, Moody’s recently found that the proliferation of funds is one cause for lacklustre returns, as ‘there are more than 9,250 mutual funds and 10,000 hedge funds, compared with 3,691 stocks in the Wilshire 5000 and 505 stocks in the S&P 500 and that this overcapacity leads to investment mediocrity, since true talent is limited and size works against the investor in the form of increased transaction costs and difficulty in identifying scalable investment opportunities.’”
 
Mell notes that the fund management industry is increasingly turning to ETFs, “arguably the most efficient vehicle for making low-cost, index-based solutions available, into a mechanism for spreading active management.  The walking dead are returning and there is no stopping them,” he writes.
 
“The SEC recently approved generic listing standards for actively managed ETFs, which currently “represent a small portion of the more-than USD2 trillion invested in US ETFs, with about USD26 billion in assets, according to Morningstar Inc. 
 
“Still, the number of such funds sold has mushroomed to 154 this year from 40 five years ago and just 14 in 2008.  Actively managed funds have largely underperformed their passive rivals. It’s important to understand that ‘the main distinction between active and passive, or index-based, ETFs is that the underlying holdings in the active ETFs are dynamic and managed similar to the way a mutual fund portfolio is managed.’”
 
“To be fair,” Mell writes, “sponsors of active ETFs say they are more attractive than actively managed mutual funds because they typically have lower management fees and feature a tax structure that makes them less costly than mutual funds.”
 
Perhaps performance will improve only because the costs are lower, he comments.
 
“However, even ‘after subtracting fees, returns from active management tend to be less than those from passive management.’  Also, when thinking about active management in general, it’s key to note that ‘even when fund managers succeed in outperforming their peers in one year, they cannot easily repeat the feat in successive years, as many studies have shown.’”
 
Mell cautions that zombie active ETFs won’t come to life all of a sudden just because the wrapper for their active management approach is different.
 
“Instead, you can expect to wake up one day like Rick Grimes and find that the more than 9,250 mutual funds and 10,000 hedge funds have been reanimated as active ETFs, most of whose strategies will likely continue to underperform passive investment management.”

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