Are active ETFs for you?

July 03, 2020

Issue #33. 

Happy Friday everyone. As we wrapped up the first half of 2020, it’s hard not to notice how well the stock market is doing, given everything else going on in the world. The market has shrugged off most of the concerns around the coronavirus, trade war, systemic racial injustice and presidential elections, and is almost back to the pre-COVID-19 levels.

But the stock market is a tale of two cities: there is a pretty big gap between growth stocks and the rest of the market in the first half of 2020. According to Morningstar, growth stocks gained 15%, while value stocks declined over -18%. That’s a whopping 33 percentage points difference between growth and value! 

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In today’s issue, we’ll cover three important questions that are top of mind for you:

  • What are active ETFs and how do I use them?

  • How do I look for bargains in the current stock market?

  • How do I find a lower-cost alternative to NASDAQ ETF QQQ?

As a reminder, the Gist is not meant to be financial advice or a recommendation to purchase any product or security.  Feel free to browse the archive here.

Here’s the quick take on today’s topics.

Quick Take

  1. ETFs that are built to track the top picks of an investment manager are called active ETFs. In today’s market, there is a big push by traditional mutual fund managers to make these ETFs more mainstream. You can use these ETFs as an alternative to their mutual fund counterparts—the key advantage (often times) is lower cost relative to their mutual fund relatives.

  2. With stock prices running high, it’s harder to find value buys among US equities. However, small-cap and emerging market stocks are still looking relatively cheap given their 5-year price range. If you’re keen on investing in broad market segments that are currently under-performing relative to their historical averages, check out US small-cap and emerging market stock ETFs.

  3. Invesco QQQ Trust has no doubt produced exceptional returns in the past—however, that’s not a guarantee it will continue to outperform in the future. If you’re looking for cheaper (and perhaps more diversified) high-tech ETFs, leverage Finny’s Comparables and Alternatives tool. Below are the results for QQQ—take a further look at Vanguard’s VGT and State Street’s XLK.

More Thoughts

  1. When investors think of ETFs, they think of passive investing strategies. Passive investing has become a favored method for investors of all stripes, as studies have shown that passive strategies tend to win out over active ones in the long term. 

    However, ETFs can also be built to track the top picks of an investment manager. In this way, they aim to provide above-average returns. An ETF that tracks a mutual fund will likely appeal to frequent traders over the mutual fund itself as a result of intraday trading capabilities. It will also appeal to people who are looking for lower-cost alternatives to active mutual funds. 

    Many actively managed ETFs have lower expense ratios than their comparable mutual fund equivalents. For example, Fidelity Total Bond ETF (FBND) is holdings-wise the same product as Fidelity Total Bond mutual fund (FTBFX), but it costs less (0.36% vs. 0.45% expense ratio for the mutual fund).

    Many of the active ETFs are also non-transparent—that’s why they are referred to as ANTs. While ANTs come with the benefits of traditional ETFs, their disclosures are minimal. Investment management powerhouses such as BlackRock or Fidelity are excited about ANTs, because they bring stock-picking strategies to the exchange-traded universe, and as such will appeal to a different demographic of investors compared to traditional mutual funds.

    To become mainstream, ANTs will have to cross a few hurdles. The sheer dominance of passive strategies is apparent—passive ETFs account for more than 95% of all ETF assets. Second, the cost of ANTs is high relative to passive ETFs. That’s why some of the biggest players in the ETF industry, Vanguard and State Street are in ‘wait-and-see’ mode.  

  2. The stock market has recovered swiftly since the March bottom, so it’s harder to find value buys among US equities. However, there are pockets of investment opportunities. As noted in our previous Gist, small-cap and emerging market stocks are still looking cheap relative to their 5-year price ranges.

    Also, plenty of opportunities remain in energy and financial services. Oil and natural gas prices still remain suppressed, as the economy is not back to normal yet.

    On the other hand, tech, consumer discretionary and healthcare sectors are looking particularly expensive now. The median stock in each of these sectors trades at a premium relative to the average analyst price target.

    If you’re keen on investing in broad market segments that are currently under-performing relative to their historical averages, check out:

    If you’re looking to make individual stock investments, you may want to research stocks that show a significant analyst price target upside as a starting point. Here are the stocks by sector exhibiting the greatest upside:

  3. Who’s a close cousin of NASDAQ QQQ ETF with a lower expense ratio? Finny’s Comparables and Alternatives tool suggests a couple of choices you may want to consider:

    • Vanguard Information Tech ETF (VGT); VGT is a good way to gain exposure to fast-growing tech companies without needing to fret about diversification. The fund has over 330 holdings (as opposed to QQQ, which has about 100). For investors who are looking to quickly increase their IT exposure, VGT could be a good solution.

    • SPDR Select Sector Fund - Technology (XLK); XLK covers all the major tech stocks in the S&P 500 and includes top hardware, software, semiconductors and services companies. Add in its low expense ratio as well as high trading volume and it’s easy to see why investors have put $28 billion in the ETF.

    Note that you can use the Comparables and Alternatives tool to find substitutes for your stocks. If one of your investment holdings was acquired or went private, you can leverage the Comparables and Alternatives tool to find stocks in the same sector or industry that have similar performance characteristics to the stock you used to own.

That’s it for today’s issue.  Have a finance or investment question you’d like us to answer? Feel free to ask us on Finny.  We’ll feature the best investment insights in our next issue.

Happy Fourth of July!

The Finny Team

Disclaimer: Nothing in this communication should be construed as a solicitation or offer, or recommendation, to buy or sell any security or product. The Gist reflects the opinions of only the authors who are associated persons of Finstead Inc. The Gist is meant to be used for informational purposes only. Past performance is no guarantee of future results, and any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in some loss. Finny does not provide personal financial planning services to individual investors.

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