Traditionally investors have viewed ETFs as passive strategies that replicate the performance of an index. That is changing, however, with the growing popularity of strategy funds that seek to add a layer of active management to what has tended to be a passive approach.
Strategy funds follow an index but their composition is weighted using a proprietary screen (higher dividend paying stocks). For example, the Powershares FTSE RAFI 1000 is based on star manager Rob Arnott’s approach which relies heavily on passive indexes but takes an active approach based on weightings such as cash flow according to this article in Institutional Investor which notes that the ETF has yielded 1.98% over the last 52 weeks with an expense ratio of 0.39%. Strategy funds can also be found in different asset classes like credit and commodities according to the same article.
The evolution of ETFs into more active products continues to push at the boundaries of traditional active management, especially as returns stay low and fees remain relatively high.
The cost pressure is sure to continue as investors focus on fees compared to low expected returns from equity and bond markets.
As firms like PIMCO launch ETF based on their own active products, this puts additional pressure on the industry to give investors low cost, low maintenance access to good managers. At the end of the day, it’s about the cost to investors.