HomeTrading News2022’s downturn is testing active equity ETFs. How to see if yours belongs in your portfolio

2022’s downturn is testing active equity ETFs. How to see if yours belongs in your portfolio

This year has delivered a brutal first half for investors, and those holding active equity exchange-traded funds are likely to be feeling the pain too. The S & P 500 , which is off by more than 20% in 2022, capped off its worst first half since 1970. The tech-heavy Nasdaq Composite , swooning as the Federal Reserve raises interest rates, was down 22.4% for the second quarter, notching its worst quarterly performance since 2008. Actively managed equity ETFs enjoyed a surge of investor interest during the broad rebound. U.S. domiciled actively managed equity ETFs saw estimated net flows of $22.9 billion in 2020 and more than $40.6 billion in 2021, according to Morningstar Direct. Thematic ETFs, led by Ark Invest’s ARK Innovation , also attracted dollars and rewarded investors with strong returns. Indeed, ARKK, which focuses on disruptive tech companies, gained about 150% in 2020. Now, as the market slumps, 2020’s hot-money darlings are suffering. ARKK, whose holdings include Zoom Video and Tesla, is off by 57% in 2022. In downturns, the blow is two-fold for investors in actively-managed ETFs that are lagging: a combination of higher fees and underperformance. Consider that the average expense ratio on an actively managed ETF is 0.68% , while equity index ETFs cost just 0.16% , on average. “What we know over a long period of time, in large part because they charge more than index strategies, most active managers have a hard time delivering the goods of giving investors performance that’s better than they would’ve had from a dirt-cheap index fund,” said Ben Johnson, global director of passive strategies research at Morningstar. Evaluating active strategies To be sure, not all actively-managed ETFs have suffered in 2022. Consider the Leatherback Long/Short Alternative Yield ETF (LBAY ), a fund that takes long positions in holdings that offer yield and short positions in securities it expects will see price declines. Top holdings include tax prep provider H & R Block, agribusiness firm Bunge and oil giant Exxon Mobil. The fund is up about 11% this year. Others, which have declined, are still beating the market. The JPMorgan Equity Premium Income ETF (JEPI) picks value names from the S & P 500 and uses options to offer income and lower volatility. It’s down about 12% for 2022. “The approach is more defensive than traditional equity strategies and it has an income component to it as well,” said Todd Rosenbluth, head of research at VettaFi. That brings investors to a key question: What advantage does this fund offer your portfolio in exchange for the cost? “In our case, we want a tilt toward value and toward smaller- and midcap stocks,” said Courtney Ranstrom, a certified financial planner and co-founder of Trailhead Planners. “It makes sense to use these more actively managed ETFs, but they don’t have to be crazy expensive. They do have to align with your overall investment thesis.” Four critical questions Even if your actively managed ETF is having a rough go in 2022, consider a few questions before dumping the position from your portfolio. What’s the purpose of this money and what’s your time frame? Provided you’re investing responsibly for longer term goals, you might be fine with investing a few dollars into a thematic ETF and taking the ride. “My hope is that you’re considering them more as something you might throw a few bucks of funny money at and not as a substitute for core long-term holdings in your serious money portfolio,” said Morningstar’s Johnson. Are these funds performing the way you would have expected? There’s a difference between a fund that’s declining with the rest of the market versus one that’s experiencing marked underperformance. “Is what I signed up for what I’m seeing? If the answer is ‘no,’ you might want to reconsider,” Johnson said. Do you have conviction in the investment approach? Two funds with similar themes can have very different underlying holdings – and that will show in their performance. “The investor wants to do some homework to understand why something is performing differently and is that good or bad,” said Rosenbluth. Dumping your losing active ETF? Find a tax-savings opportunity. When you sell losing positions in a taxable brokerage account, you can use those losses to offset capital gains elsewhere – which can help you save on taxes. Reinvest the proceeds so that you diversify your portfolio and remain in the market. “Don’t just say ‘this isn’t working’ because it’s been a rough six months,” said Ranstrom.

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