ETF Expert

You may have been reading about the latest "rage." More specifically, several prospective fund providers are gearing up to offer actively managed exchange-traded funds.

In previous posts, I have argued AGAINST using newfangled, actively managed ETFs. For one thing, you lose the tax efficiency and lower costs that come with index ETFs. What's more, index ETFs are more "trade-able." The exceptionally low volume on actively managed ETFs adversely impacts price execution, resulting in an unnecessary hit to overall performance.

Actively managed ETFs do not differ all that significantly from the closed-end funds (CEF) currently available in the marketplace. Some people may want you to believe that there are big differences. They'll point to slightly lower costs. They'll talk about greater transparency on the active ETFs.

Still, closed-end funds still represent diversified baskets of stocks (i.e., fund) that trade like individual securities (i.e., stock). It follows that if we wish to get an idea of how actively managed ETFs will fare against traditional index ETFs, we can make a reasonable comparison to actively managed closed-end funds (CEFs) that are already in existence.

1. China — The China Fund (CHN) versus the iShares FTSE China 25 Index Fund (FXI). The China 25 exchange-traded index fund, FXI, has been around for nearly 4 1/2 years. That may not be a long time horizon, but it is long enough to look at 3 1/2 years of bullish price movement and 1 year of bearish price movement.

Since the index ETF, ticker FXI, began trading on October 4, 2004, it has gained roughly 53% in value. If one chose the actively managed closed-end fund, ticker CHN? The gain was a significantly less robust 18%. (But what's 3,500 basis points between friends, right?)

2. Mexico — The Mexico Fund (MXF) versus the iShares MSCI Mexico Index Fund (EWW).  The index ETF for investing in Mexico, ticker EWW, has been around for a much longer time period. In fact, over the last ten years, EWW has an astonishing gain of 233%!

Surely, we're going to be even more mesmerized by the extraordinary benefits of stock picking skill by the actively managed Mexico Fund (MXF), right? Well, 141% is a superb return over the last decade. Nevertheless, it falls wayyyyyyyyy short of the index ETF, the iShares Mexico Index Fund (EWW).

3. Japan — The Japan Equity Fund (JEQ) versus the iShares MSCI Japan Index Fund (EWJ). Perhaps stock picking in emerging areas like China, Korea, Mexico… perhaps indexing is better for countries where the companies are less well-known. But what happens if you pick a highly developed market like Japan, a country with the 2nd largest economy in the world?

The 10-year return for the iShares MSCI Japan Index Fund (EWJ) was effectively 0%, not unlike the return for major U.S. equity indexes. Still, the active management prowess of the Japan Equity Fund (JEQ) was a lot less sumptuous with a negative return of -35%. Ouch!

In fairness to the closed-end funds that are actively managed, I DID NOT sample 30 or more of them. In that manner, I might have come up with something that is statistically relevant.

That said, there are studies that show index funds outperforming their peers 80%-85% of the time. Why an investor would hope to find the 1 fund out of 5 where stock picking might make the difference is beyond me.

In truth, traditional index ETFs have numerous advantages over most actively managed ETFs as well as actively managed CEFs. Will there be exceptions to the general rule? Sure. Nevertheless, sticking with well-known, widely used, traditional index ETFs will make your life easier… and probably, a whole heck of a lot more profitable.

If you'd like to learn more about ETF investing… then tune into "In the Money With Gary Gordon." You can listen to the show "live" or via podcast or on your iPod at this link.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.