Active Equity ETFs Scorecard

The tough business of delivering alpha continues to challenge managers.

[This article appears in our July/August 2020 issue of ETF Report.]

There is a notion in the investment industry that volatile markets are the perfect environment for active managers to succeed.

If that is true, the first two quarters of 2020 should have been an alpha-generation bonanza.

A global pandemic saw the S&P 500 plunge from still-fresh record highs down 30% by March 23—the bulk of the decline happening within a short month. The benchmark then found a bottom and rallied 34% just like that, through June 15. Other major indexes—the Nasdaq Composite, Russell 2000, Dow Jones Industrial Average—all saw similar eye-popping action.

Alpha is said to hide in the space between winners and losers, amid the price dislocations market turmoil can trigger. But many active managers continued to leave investors wanting. Consistent, across-the-board outperformance among active equity ETFs did not follow the market’s wild ride this year.

Take, for example, the TrimTabs All Cap U.S. Free-Cash-Flow ETF (TTAC). The fund is designed to outperform the Russell 3000 through a quantitative fundamental approach that hones in on companies with strong free cash flow and profitability growth, with a focus on quality.

Through mid-June, TTAC was lagging passive counterparts iShares Russell 3000 ETF (IWV) and the Vanguard Russell 3000 ETF (VTHR) by at least 150 basis points, or 1.5 percentage points. Remember that TTAC charges three times the price of IWV, and six times the price of VTHR for its alpha-seeking strategy.

What happened? Mega caps.

“Our goal is to beat the Russell 3000, but it’s been a tough case to make because mega caps continue to lead,” TrimTabs CEO and CIO Bob Shea said. “It has been a monster to beat.”

“I’m a big believer in passive investing, but I also believe there’s a quadrant for innovative managers to generate alpha, and be paired with passive strategies,” he added. “We fit that. But has it been easy? No.”

TTAC Vs. IWV & VTHR Performance

Source: Bloomberg, 12/31/2020-6/30/2020

Shea’s conviction on the firm’s value proposition has not been shaken at all, as he says a longer time horizon will offer better opportunities for TTAC, but some investors may have had their doubts. TTAC faced net redemptions of about $14 million through mid-June, not insignificant for a $100 million fund.

But TTAC is not alone.

US Total Market Equity Snapshot
In the U.S. equity total market segment—the same segment in which TTAC competes—only a handful of funds among 21 actively managed ETFs in this space beat the benchmark between Jan. 1 and June 15, according to FactSet data. The benchmark for comparison here is the performance of the Vanguard Total Stock Market ETF (VTI).  

Active U.S. Equity ETFs

FactSet data; YTD through June 15, 2020.

The data shows that underperformance was not tied to any single manager, but managers across various firms, and through very different approaches, fell short of the vanilla portfolio.

Some of Vanguard’s own active-takes on this universe of stocks landed among the worst performing in this space. The Vanguard U.S. Multifactor ETF (VFMF) plunged 17.3% through June 15.

By comparison, the passive VTI was down 4.4% in that same period—that is a massive 13 percentage-point underperformance for VFMF, an active multifactor fund built around value, momentum, quality and low volatility in search of long-term capital appreciation.

VFMF Vs. VTI Performance

Source: Bloomberg, 12/31/2020-6/30/2020

On the flip side, one of the best-performing active funds in this total market U.S. equity segment is a fund-of-funds portfolio that can add or remove a hedge position—the AGFiQ Dynamic Hedged U.S. Equity ETF (USHG).

In 2020, through June 15, while VTI was down 4.4%, USHG was down only 1.3%. Both funds were in the negative, but USHG delivered 300 points of outperformance.

USHG Vs. VTI Performance

Source: Bloomberg, 12/31/2020-6/30/2020

USHG isn’t your traditional total market equity ETF. It’s built around two quantitative models: one focused on sector allocation, and the other on assessing the risk environment.
 
The portfolio manager rotates among all S&P 500 sectors using Sector SPDRs, and overweights or underweights any particular sector (up to a 6% tilt in either direction relative to market-cap weighting) given the market at the time.

The sector mix matters, but the biggest active element to USHG is its addition or subtraction of a hedge in the form of an allocation to the AGFiQ U.S. Market Neutral Anti-Beta Fund (BTAL).

BTAL is a passive ETF that goes long low-beta companies and shorts high-beta stocks. The fund is negatively correlated to the equity market, and offers insurance for downside protection.

In 2020, as the stock market plunged through late March, USHG’s allocation to BTAL—which typically sits around 15-20%—supported the fund’s performance even as the S&P 500 dropped sharply.

“They say the market goes up like an escalator, and drops like an elevator. This fund does a good job when the market drops,” AGF Investments CIO Bill DeRoche said. “In USHG, you take a core equity position and add insurance to it, giving up a bit on the upside, but hedging the downside.”

“Cumulative growth is, in part, a function of volatility,” he explained. “If you reduce volatility, you can still end up with more money longer term even if you give up some of the upside.”

The risk assessment model that calls out the need for a hedge is run every single day. Following the market bottom in late March, USHG eliminated its allocation to BTAL, and went back to fully participating in its sector rotation strategy, holding on to its edge on VTI.

It is that active manager discretion that has allowed the fund the flexibility to adjust between sectors, BTAL and even some cash in search of outperformance.

“There are two components to good active management,” DeRoche added. “The first is a good forecast. The second is bet size.”

“If volatility increases, you have to be cognizant of how much you have at risk at any given time,” he said. “Make sure you can live with the size of the bets if things don’t go the way you want. A lot of times, active managers are not quick enough to adjust when they’re most at risk.”

Other outperforming funds among total market U.S. equity active ETFs also offered some novel angle compared with the vanilla VTI—either focused on a winning factor, or relied on artificial intelligence to pick the most-likely-to-win stocks, or favored sectors based on a selection model that identifies leaders and laggards.

But the vast majority in this segment underperformed in the first few months of 2020, a fact that’s also true across other equity segments.

US Large Cap Equity Snapshot
In the large cap U.S. equity space, only a third of active ETFs in this segment outperformed the benchmark Vanguard Mega Cap ETF (MGC), according to FactSet.

Active Large-Cap Equity ETFs

FactSet data; YTD through June 15, 2020.

Among the leaders, another hedged ETF stood out: the Invesco S&P 500 Downside Hedged ETF (PHDG). As MGC slipped 2.5% year to date through June 15, PHDG rallied 12.8%.

MGC Vs. PHDG Performance

Source: Bloomberg, 12/31/2020-6/30/2020

PHDG’s secret to success this year is no secret. The fund invests in S&P 500 equities—offering fairly vanilla exposure to U.S. large caps—but it can also hold VIX futures and cash in times of market turmoil, a feature that came in handy in the massive drawdown earlier this year.

In bull markets, PHDG can find itself lagging, but it delivered its promised alpha in the form of a downside hedge when it mattered most.

By contrast, the worst-performing ETF among U.S. large cap active funds was the AdvisorShares Dorsey Wright Alpha Equal Weight ETF (DWEQ), down nearly 22%, or a plunge almost 10 times as deep as MGC’s.

DWEQ invests in large cap equities that show good relative strength within sectors that are also showing good relative strength. But the portfolio is equal-weighted, something that can be detrimental to performance in markets driven by a few names.

Again, in the large cap equity space, all sorts of strategies from various managers found mixed levels of success given market conditions.

ARK Turning Doubters Into Believers
Lest you be losing faith in active managers’ ability to deliver alpha in the equity space consistently, or if you find yourself reminded of the Standard & Poor’s SPIVA data—which shows active managers underperform benchmarks 70-90% of the time in any given year—remember ARK Invest.

In 2020’s grimmest hour, the firm, again, didn’t disappoint. Five of ARK’s ETFs topped best performance active fund charts so far this year.

The ARK Next Generation Internet ETF (ARKW) has led the pack—the best-performing active ETF of 2020. Through June 15, the tech-focused fund delivered more than 37% in gains.

ARKW is a tech ETF that’s global in scope, so a comparison to the U.S. tech sector via the Technology Select Sector SPDR Fund (XLK) isn’t fair. A better measuring stick would be the competing index-based O'Shares Global Internet Giants ETF (OGIG), which also had an impressive run, rallying more than 35% in the same time period, but it fell just shy of ARKW’s gains.

Part of ARKW’s success this year, and OGIG’s for that matter, is the focus on internet and cloud computing names. This segment has been on fire given the work-from-home, remote economy theme that dominated the first half of 2020.

But ARKW’s willingness to go where few funds go, in search of companies outside the proverbial “tech box” may be its secret. These names often fly under the radar, and can be undervalued given their growth potential in the context of big tech.

ARKW’s top holdings include Tesla, Square Inc., Roku and Splunk; whereas OGIG is led by names like Amazon, Alphabet, Microsoft and Alibaba. They are vastly different portfolios navigating the same universe.  

ARKW Vs. OGIG & XLK

Source: Bloomberg, 12/31/2020-6/30/2020

Other ARK ETFs also stood out in the first half of the year. The ARK Innovation ETF (ARKK), up 29% year to date, is the best-performing active ETF in the global total equity segment. A passive benchmark for reference, the Vanguard Total World Stock ETF (VT), dropped 7.6% in the same period.

Active Global Equity Total Market ETFs

FactSet data; YTD through June 15, 2020.

The ARK Genomic Revolution ETF (ARKG) rode the all-eyes-on-health-care wave to 36% gains with a portfolio of companies in the business of delivering breakthroughs in genomics—including developers of therapeutics, treatments and diagnostics, with a strong focus on biotech.

The portfolio’s tilt toward smaller names on the cutting edge of this segment worked out well relative to the index-based market-cap-weighted iShares Genomics Immunology and Healthcare ETF (IDNA), which lagged ARKG by 16 percentage points. IDNA is up only about 20% in the same period.

The ARK Fintech Innovation ETF (ARKF) and the ARK Autonomous Technology & Robotics ETF (ARKQ), too, sit among the best-performing active ETFs of 2020.

ARKW, ARKG, ARKK, ARKF & ARKQ Performance

Source: Bloomberg, 12/31/2020-6/30/2020

“What sets us apart is our top-down research,” ARK Invest founder and CEO Cathie Wood said. “We’re looking at tech that’s cutting across sectors and causing many companies to fall through the cracks of traditional research.”

“This is not a niche strategy,” she noted. “It’s the way the world is going to work. And this kind of active research is being rewarded in the marketplace.”