By comparing two low-volatility offerings in the US, it’s easy to see why ETFs continue to gain at the expense of other funds.
I’m referring to Invesco Powershares’ S&P 500 Low Volatility ETF (NYSE Arca: SPLV) which, as we wrote about yesterday, has attracted over US$1 billion in assets since its launch in May last year, and Janus Intech’s actively managed low volatility strategy.
Invesco Powershares is the fourth-largest US manager of exchange-traded funds. Janus doesn’t yet offer ETFs (though it did apply last year to the US regulator to launch some actively managed ones).
Invesco Powershares saw US$4.4 billion of ETF inflows last year, well short of the US$36 billion, US$29 billion and US$17 billion recorded, respectively, by Vanguard, BlackRock and SSgA, the US market’s biggest three ETF firms. But Powershares’ inflows were still respectable and totalled over 10 percent of the firm’s previous year-end assets. SPLV was a particularly successful launch and made up around a quarter of the new money arriving.
Janus's asset management business, meanwhile, suffered net redemptions in all four quarters of 2011.
There are two simple reasons why ETFs continue to gain market share from traditional funds: they are cheaper and more flexible.
Janus’s Intech subsidiary, which specialises in quantitative equity portfolios, charges 0.35 percent to manage a separate managed account following a low-volatility approach. Separate accounts command the lowest (wholesale) rates available in fund management and Janus sets a minimum portfolio size of US$50 million. Although it doesn’t offer a pooled fund version of its low volatility strategy, for its other mutual funds, which have a minimum investment amount of US$1 million, Janus typically adds another 20 basis points to the separate account rate.
Invesco Powershares, meanwhile, charges only 0.25 percent for its ETF. You can buy a single ETF share for US$26, making the fund accessible for everyone (I’m ignoring the brokerage commissions and bid-offer spread you face when dealing in an ETF, but for an investment amount of a few thousand dollars in a relatively liquid fund these are minimal). By comparison with a traditional mutual fund or separate managed account, the ETF, let’s remember, also offers intraday tradeability, real-time performance benchmarking against its index and full transparency of its holdings.
The two funds’ management approaches are not identical: the S&P 500 low volatility index tracked by the Invesco Powershares ETF, SPLV, uses a simple ranking of one-year historical volatilities to select 100 shares from the broader S&P 500 stock index, giving those with the lowest recorded risk a higher weighting. Intech uses a more complicated, minimum variance algorithm to reduce volatility and stresses in its marketing literature that its estimates of stocks’ historical variability of return, and of their interconnectedness, are proprietary, and “can be quite different from peers’ portfolios, which use off-the-shelf risk models”.
You’re paying quite a bit extra, in other words, for a less transparent, tailor-made approach to minimising risk. With the cheaper, index-based strategy of the ETF, you know what you’re getting and you can see how it is put together.
Judging by the 2011 fund flow figures, the contest between ETF managers and their more expensive active counterparts is very uneven. Investors continue to vote with their feet, deciding that they are quite happy to go down the indexed route and leave behind the more expensive, proprietary and less flexible option.