Running an ETF or Index Fund, Actively Managing a Fund Using Customized Index and Active Indexing

These concepts could be confusing, that’s why I list them in the title. To decompose, there are two parts. Running an ETF or index fund ought to be compared to actively managing a fund using a customized index, while active indexing is an entirely different thing to understand.

Let’s elaborate on the former part, running an ETF or index fund versus actively managing a fund using a customized index with concrete examples.
Running an ETF or index fund is basically to replicate or stratify-sample the make-up of an index, aiming to track the performance of the underlying index as close as possible. There are intricacies such as handling cash, liquidity, price discrepancies, equity ownership or participation restriction across the globe etc, however, the framework of the fund is set or defined by the index already. The chief goal is to track index performance. For instance, we can take a look at the earliest and largest ETF in the market – SPY, comparing it to the index S&P 500, the SPY fund tracks closely to the index with a consistent higher margin.

spy sp50

It’s worth noting that within this ETF or passive index management vertical, there is the burgeoning and formation of “actively managed ETFs”, in comparison to the real, strictly passively-run ETFs.  Among over 7000 existing ETFs in US market, 17 fall under this category and possess AuM above $1 billion. The majority of them are fixed income ETFs, with three equity and one commodities ETF. The top one is PIMCO’s PIMCO Enhanced Short Maturity Active ETF (MINT), amassing $8 billion assets as of March 2018.

The following chart depicts MINT’s performance, not remarkable per se, given the steep 0.35% expense ratio, I doubt why investors would love to pour $8 billion into this fund?

MINT

Actively management has all centered the tenet that superior managers/analysts are able to beat the market proxied by broad market indexes such as Russell300, MSCI ACWI World or S&P 500. They believe they are able to parse complex information, dig out concealed inconspicuous intelligence with their fundamental research skills or sophisticated quantitative models to get ahead of the market. Hedge Funds are good examples of active management. For their performance to be fairly measured, it’s necessary a corresponding index is existent in the market, if not, the asset owners/active managers’ clients mandate the creation of such one, so they can calculate information ratio to assess whether they hand their money to these active managers wisely. Here, Nikko Asset Management hires/partnered with ARK Invest to run Nikko AM’s Global Fintech Equity Fund is a typical example. ARK is the sub-advisor to this fund, which was launched in December 2016, now accumulating total asset of over JPY 75 billion as of July 2017. (press release). The underlying index is FactSet Global FinTech index(FDSFTPR), created by FactSet index solution by systematically filtering through an industry classification system to form a list of fintech stock components. Given the industry expertise and know-how, ARK Investment has been able to outperform FDSFTPR consistently and steadily over the past almost two years.

Lastly, no matter managers are using the index for passive or active funds, they both need indexes, making the business space of creating indexes growing large and fast. Over the course of last ten years, the concept of indexing itself has been evolved from a passive mathematical equation to a more and more complicated, thusly active activities.

According to Active Index Investing, mainly authored by Steven Schoenfeld, Active Indexing has multiple meanings, the principal one would be – “benchmark construction and selection is active”. There are myriad of choices of different strategies, themes, features for indexes in the market. They all supposed to fulfill the following 7 key criteria:

Completeness
Investability
Clear, Published Rules and Open Governance Structure
Accurate and Complete Data
Acceptance by Investors
Availablity of Crossing Opportunities, Derivatives, and Other Tradable Products
Relative Low Turnover and Related Transaction Costs

Nevertheless, a great amount of creativity or ingenuity is highly required in this “active index” business realm.

 

 

 

 

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.