Mixed Performance For Top Alpha-Seeking ETFs

The popularity and, perhaps, utility of beta is being eclipsed. That’s led ETF issuers recently to go active, trying to beat the broader market. Does it work, and at what cost?

Exchange-traded funds (ETFs) came into this world as passive vehicles, designed to offer low-cost and tax-efficient exposure to indices. Their raison d’être was beta, pure and simple.

But, things became complicated. Competition in the ETF space long ago consumed all the licensing opportunities for the well-established indices developed by Standard & Poor’s, Dow Jones and Russell. Now it’s a world of “self-indexing,” as ETF sponsors manufacture novel (and cheaper) exposures of their own.

The trend has been fueled by a growing interest in “smart beta,” “strategic beta,”  “fundamental indexing” or whatever verbal construction that bespeaks using something other than a cap-weighted vanilla index. The cascade of factor-based investment strategies in ETF wrappers—now up to nearly 800 such products, according to the ETF.com website—began with the launch of the first fundamental index ETF in 2005.

Most recently, the popularity—and some would say, utility—of beta is being eclipsed. You can see that (Chart 1) reflected in a stair-step decline in the CBOE S&P 500 Implied Correlation Index (CBOE: KCJ). The index is derived by comparing the cost of S&P 500 index options to the prices of options on the benchmark’s largest component stocks and declines as market expectations of correlation within the index weakens. In other words, the index falls as beta plays cede ground to alpha-seeking adventures.

So, the ETF business is getting adventurous, going beyond beta to include a whole new category of alpha-seeking ETFs. According to ETF.com, these alpha-seeking ETFs are “equity funds attempting to outperform the market with various investment strategies,” a rather nebulous and seemingly inclusive characterization at best. A total of 78 products are installed in this category, with just a half dozen (8 percent) awarded the website’s top grades (‘A’ or ‘B’).

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DisclosureBrad Zigler pens Wealthmanagement.com's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) ...

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