Consider These Market-Beating ETFs Now

Investors seem to be in love with index funds, whether ETFs or mutual funds, as opposed to funds that attempt to beat the market through active management.

Smart choice. According to Refinitiv, fully 62.76% of actively managed ETFs and mutual fund underperformed their benchmarks during 2022 while only 37.24% added valued, or alpha. But that is not the whole story.

As I pointed out in my Oct. '22 article here on Seeking Alpha, with regard solely to Vanguard ETFs and mutual funds, actively managed funds, especially ETFs, were doing better compared to their unmanaged, same category alternative choices over the prior 12 months. Was this just a fluke or were Vanguard fund managers particularly skillful? Or, did it perhaps suggest that actively managed funds might be entering one of those relatively rare periods where many active fund managers might have an advantage? While investing in passively managed funds has proven to be a wise choice almost year after year, might there be circumstances tending to favor a switch away from passive management, at least temporarily?

In order to further examine the last of these possibilities, I decided to now look at the top 10 ETFs in terms of assets under management (none of which are Vanguard ETFs) to see their most recent 1-year past performance compared to their appropriate benchmark, to see whether investing in these funds has paid off in terms of index-beating performance.

Here's how I proceeded:

The 10 actively managed ETFs with the most under management as of March 9 were identified here. I then researched how these funds performed over the trailing 12 months. I also identified how each did in comparison to the appropriate index for their particular category to see if each ETF had exceeded their passively managed benchmark or not.

The resulting data is shown in the table below.

Actively Managed ETFs with the Most Assets Under Management

As can be seen in the last column of the table, fully 9 out of the 10 ETFs beat their particular benchmark.

Implications

The results, combined with those presented in my Oct. '22 article cited above, suggest that the outperformance of actively managed ETFs likely was not a fluke. Rather, it seems more likely that special conditions existed making it relatively easier for human beings rather than rote, passive selection procedures, to excel at constructing an outperforming fund portfolio.

To discuss this further, let's look at what some of these conditions might be.

- Over the last decade or even longer, investors have poured so much money into index funds that now better opportunities may lie outside of the realm of stocks in indexes and into stocks that give "live" managers the opportunity to select them without the restraints of indexes.

- In many instances, index funds tend to be dominated by large capitalization stocks, such as technology and growth stocks. These stocks have led the markets higher over the last decade or more. Now that these stocks are at least temporarily out of favor, active managers can simply avoid them and focus on other stock selections, including possibly value stocks and those that tend to do less poorly if the economy slows significantly or enters a recession. Of course, these possibilities are currently on investors' minds.

- So long as there is the possibility of an economic downturn, active managers can avoid being 100% invested in stocks and go significantly to cash. Index funds do not have that option.

- Active bond fund managers may have several options in a rising short-term rate environment, as still promised by the Fed, such as avoiding bonds with relatively longer durations or also going to cash if they reason that perhaps even cash will now outperform the bonds that are part of their benchmark indexes.

Final Thoughts

Index funds may be great vehicles for long-term buy-and-hold investors, but for those investors who wish to best capitalize on shorter-term trends in the market, I would recommend actively managed funds for at least a portion of their portfolio.

Which of the above 10 most owned actively managed funds would I recommend?

In a bear market for stocks and continued pressure on bonds from an aggressive Fed, until market conditions turn around, investors should continue to expect very little from their investments.

Funds that are very short-term bond funds (JPST, MINT, FTSM, ITSH) are almost like hiding out in cash with very limited return potential. In fact, those funds that currently have a high cash position may now offer a greater return as interest rates continue to climb. Corporate bond funds could suffer in the event a recession does hit (FPE). Funds that primarily remain invested in stocks offer the best potential, provided they are not significantly invested in growth stocks (JEPI, DFAC, DFAT, AVUV). Long-term readers of my many prior articles will recognize that I have repeatedly correctly cautioned against growth stocks given that markets almost always rotate out of over-performers and into under-performing categories.

The one fund I would definitely not recommend is ARKK. Here we have growth stocks galore. Some investors have flocked to this fund, especially after the phenomenal 2020 performance of 152.8 that year. But since then, it has been one of the worse ETFs around, losing an especially large 66% in 2022. Those who would like to try to make a killing should go ahead and try but for most others who would be perhaps happy to earn 10 or 15% at most this year, but likely much less, I would avoid this ETF.