Inside Actively Managed Equity ETFs

By Herbert Blank

Actively managed ETFs have evolved very differently from index-driven ETFs.  Most of the assets have been accumulated in actively managed fixed income ETFs while the vast preponderance of Assets Under Management in Equity ETFs are index driven. Although there are many legacy reasons for this, the fact is that the efficiencies of the ETF structure, tax and operational, benefit fund shareholders of actively managed funds even more than the benefits long realized by those holding index-driven ETFs.  I wrote in article in (then the Journal of Indexes) in 2002 about these benefits. They still apply today.  I am happy to send a copy to anyone who is interested.

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Perhaps the most overlooked benefit that pertains especially to active managers is that the structure insulates them from daily cash flows and cash drag.  This fact means that all their trades can be based solely on investment decisions, not the need to liquidate a position. Often a manager forced to sell will choose a fresher idea with no capital gain over a stale idea with a significant embedded capital gain.  This forced choice typically works against alpha.  The need to keep cash available for redemptions can result in cash drag in an up market.  Combined with all the well-known advantages, I believe an actively managed fund that switched to the ETF structure levels the playing field with passive benchmark ETFs. 

Today’s analysis covers seven actively managed ETFs:  

AIEQ, AI Powered Equity ETF by ETF Managers Group

ARKK, ARK Innovation ETF

ARKW, ARK Next Generation Internet ETF 

CWS, Advisor Shares Focused Equity ETF

DYNF, BlackRock U.S. Equity Factor Rotation ETF

FTHI, First Trust Buy/Write Income ETF

HUSV, Horizons Low Volatility ETF

Research Reports on each of these ETF’s are available here:

AIEQ seeks long-term capital appreciation within risk constraints commensurate with broad market US equity indices.  The fund applies proprietary analytical algorithms to artificial intelligence (AI) technology, which can process over one million pieces of information per day, to build predictive financial models on approximately 6,000 U.S. companies. The technology continually analyzes data and models in its active stock selection process, and derives an optimal risk adjusted portfolio consisting of companies with high opportunities for capital appreciation. The fund is actively managed and discloses all portfolio holdings daily.

ARKK is an actively managed Exchange Traded Fund (ETF) that seeks long-term growth of capital. It seeks to achieve this investment objective by investing in domestic and foreign equity securities of companies that are relevant to ARKK’s investment theme of disruptive innovation. ARK defines ‘‘disruptive innovation’’ as the introduction of a technologically enabled new product or service that potentially changes the way the world works.

ARKW is an actively managed ETF that seeks long-term growth of capital by investing under normal circumstances primarily (at least 80% of its assets) in domestic and U.S. exchange traded foreign equity securities of companies that are relevant to the Fund’s investment theme of next generation internet.  The Adviser believes companies within this ETF are focused on shifting technology infrastructure to the cloud, enabling mobile, internet-based products and services, new payment methods, big data, artificial intelligence, the internet of things, and social media.

CWS invests in fundamentally sound companies that have shown consistency in their financial results and demonstrated high earnings quality.  The investment strategy has been employed by the portfolio strategist, Eddy Elfenbein, since 2006 and is published annually as the Crossing Wall Street “Buy List.” As a focused portfolio, CWS will typically look very different than a traditional benchmark like the S&P 500. CWS can be used in a portfolio to add a fundamental alpha seeking manager in your domestic equity allocation.

DYNF seeks to outperform the investment results of the large- and mid-capitalization U.S. equity markets by providing diversified and tactical exposure to style factors via a factor rotation model.  The fund selects stocks based on rewarded factors: quality; value; size; low volatility; and momentum. BlackRock’s active management team dynamically emphasizes investment styles based on forward-looking insights.

FTHI has providing current income as its primary investment objective. Its secondary investment objective is to provide capital appreciation. FTHI uses a classic buy/write strategy to pursue these objectives by investing in equity securities listed on U.S. exchanges of all market capitalizations and by utilizing an “option strategy” consisting of selling U.S. exchange-traded covered call options on the Standard & Poor’s 500 Index.

HUSV is an actively managed ETF seeking to The Fund’s investment objective is to provide capital appreciation with a secondary objective of controlling expected volatility.

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There are many more actively managed ETFs.  All of these were selected because they have very distinctive strategies for selecting US stocks and 5-year actual histories.  Let’s compare how they have worked recently and historically using data from ValuEngine’s ETF reports from January 29, 2021. SPY, the largest S&P 500 ETF and non-managed, is provided for benchmarking. The top performers in each category are highlighted by bold black Italics.  The worst performers are highlighted in bold red italics.


Ticker VE Rating # of Stocks 1-Yr Price Return 5-Yr Avg Price Return Volatility Sharpe Ratio Dividend Yield
AIEQ  4 113 33.31% 11.2% 24.0% 0.47 0.4%
ARKK 5 34 171.3% 36.1% 31.4% 1.30 1.4%
ARKW 5 34 155.1% 36.9% 29.3% 1.24 1.2%
CWS 2 25 15.6% 13.0% 16.6% 0.78 0.3%
DYNF 2 616 12.5% 13.0% 20.8% 0.63 1.5%
FTHI 1 125 -10.0% 0.1% 13.7% 0.01 4.7%
HUSV 2 74 -2.9% 8.1% 16.7% 0.49 1.3%
SPY 3 500 15.5% 12.1% 15.4% 0.79 1.5%

ARKK and ARKW dwarf everything. The returns achieved in the past one- and five- year periods are astronomical.  They do exhibit the highest volatily, but the impressive Sharpe Ratios indicate that the returns more than compensated.  Both are rated 5 by ValuEngine’s model, the highest rating.  They are extremely similar.  The top 9 holdings in each were the same stocks.

AIEQ using IBM Watson as its active manager has enjoyed a very strong 12 months with a 33.3% return which partially accounts for its 4 rating from ValuEngine.  Five year results are not so impressive, ranking only 6th best among eight ETFs.  Its 5-year Sharpe Ratio which can be thought of as how much an investor is compensated for price volatility is the second worst of the 8 ETFs being compared.  Interestingly, Watson has avoided owning stocks that pay dividends, reflective of the considerable underperformance of value stocks in recent years but not attractive for income investors.  

CWS is a heavily focused ETF from Advisor Shares, the first brand to promote active and fully transparent ETFs.  They’ve navigated the choppy seas of the past five years better than most actively managed mutual funds with returns edging SPY with 1- and 5-year returns better than the index although with slightly more volatility combining for a virtual tie in Sharpe Ratios.  On a total return and income basis, SPY has the edge since CWS has the worst dividend yield in the study.  CWS had currently gets only two Vs from ValuEngine which is below average.  However, those concerned that we are in a second tech bubble may find it more comfortable fit with a team of traditional focused portfolio managers that are free to shift nimbly out of tech if their disciplined approach back up such a shift.

DYNF is designed to shift sectors as needed.  Despite a below average 2 V’s out of 5 from ValuEngine, I think the well-diversified ETF is worth considering alongside CWS.  Its return and volatility stats don’t quite measure up to those of CWS but they are competitive compared to actively managed mutual funds. I also believe its broader approach may allow it to be more resistant if tech stocks become out of favor with the market.  

HUSV, in contrast, impresses me less than the 2 V’s it earned from ValuEngine.  It lags the S&P 500 in every category and by a lot in some.  It seems to have trouble adhering to its own objectives. It has a low-volatility objective but had more volatility than the index and 3 other ETFs.  

FTHI has a well-deserved lowest ValuEngine rating of 1.  Its high-income strategy has underperformed disastrously even while attempting to provide income and supplement returns by selling covered-call S&P 500 index options.  I generally am a fan of buy/write strategies and have owned both PBP and QYLD at times in the past.  However, FITH has a mismatched risk problem. Buy/Write depends upon the index beneath the options performing similarly to the portfolio.  Often the S&P was up which meant the options were called while the FTHI portfolio was going down.  In other words, the hedge didn’t work.  The only thing that performed as expected was the nearly 5% yield.

The ETFs from ARK Asset Management, founded in 2014 by Catherine Wood, have been an amazing success story.  She started off small. ETF veterans scoffed at the chance that this independent newcomer with an unknown brand could ever make it in the tough ETF world where ETF Death Watch is a favorite pastime. $100 million is generally considered needed by the second year for an ETF to survive.  In a New York article she explained that all her friends thought she would fail.  

ARKK now has $17.5 Billion under management.  ARKW has more than $5 Billion AUM. Another ARK fund specializing in Autonomous Technology, ARKQ, has nearly $2 Billion.  After years of experts saying Cathie Wood couldn’t succeed with the Ark Funds, now those same experts are expressing doubts she can continue because she’s had too much success. That may turn out to be a good thing for investors in the ARK Funds.

Bloomberg’s ETF maven Eric Balchunas wrote an article postulating that ARKK may well be the new Janus Twenty, a mutual fund that concentrated in technology and also enjoyed a 5-year run of stratospheric returns until 2000, then crashing with a thus when the tech bubble popped. I found three other articles by others making the same analogy. In general, a fear has persisted since 2016 with the explosive growth in market cap of Apple, Google, Facebook, Amazon and two or three others that we are in the midst of another tech bubble.  Going to Page 3 of the ValuEngine ETF Reports, let’s take a look at the relative susceptibility of these funds to an implosion in the innovative sectors where ARK has its greatest concentrations.

Ticker Technology Medical Auto Other
AIEQ  31% 15% 5% 49%
ARKK 37% 35% 10% 18%
ARKW 36% 35% 10% 19%
CWS 9% 11% 0% 80%
DYNF 31% 12% 3% 54%
FTHI 20% 15% 2% 63%
HUSV 15% 11% 1% 73%
SPY 32% 12% 2% 54%

There are a number of takeaways here, some surprising. The ARK funds are only 4%-5% higher in their tech sector weights than SPY.  The most over-weighted sectors are Medical, almost 3 times the weight as in SPY and Auto, all in Tesla, at 5 times the weight of SPY.  Therefore, relative to SPY, the biggest danger to ARKK investors is if a bubble is about to pop in companies involved in disruptive innovation in the medical industry. This includes top 10 holdings such as Invitae Corp, NVTA and CRISPR Theraputics, CRSP.  Working against such fears, the Janus Twenty was also far more concentrated in tech than the 34 stocks held by ARKK. 

Interestingly, the more concentrated CWS with just 25 holdings is making the opposite bets, vastly under-weighting technology and autos while over-weighting Financials and Construction.  Not surprisingly, the active ETFs emphasizing high income and low volatility are both under-weighted significantly in technology but not as much as CWS.

There is quite a variance in performance and other characteristics among the actively managed US Equity Funds included in this survey.  From the perspective of most small investors, my opinion is that ARKK or either of its cousins ARKW and ARKQ, are still attractive holdings despite the stratospheric success.  However, I would consider them satellite allocations, no more than 20% of your total equity allocation, rather than a suitable core holding such as SPY or Vanguard’s Total Market ETF, VTI which is my personal core US Equity holding.  Another reasonable candidate is the even-more focused CWS.  Given its competitive return history, its well-explained disciplines, and especially the fact that its focused concentration is not at all a duplication of those in the ARK funds, adding CWS as a second satellite holding is interesting. Perhaps at 50% of your position in ARKK.  It should add nicely to overall US equity diversification.

If you are not comfortable with an index as your core holding, IBM Watson’s ETF AIEQ is a prudent and well-structured alternative.  It provides index-like sector weightings with potential for alpha.  Although it did not perform as well recently, those looking for alpha and oversight provided by actual human professional portfolio managers within a quantitative framework could find their needs satisfied by Blackrock’s DYNF.  I actually believe their process and disciplines to be sound.  

Since HUSV didn’t really provide low volatility and FTHI has a significant mismatched risk problem in its hedge, I cannot recommend any investment in either at this time.

In a recent survey, the majority of ETF professionals believed that the most significant event on the horizon will be conversion of existing mutual funds to the ETF structure. This would put the managers on a level playing field and benefit the fund shareholders immensely.  Since most of these funds are actively managed and that will continue, most likely employing semi-transparent methods now approved by the SEC, the ability to compare actively managed ETFs, using reports such as the ones from ValuEngine used in this study, becomes much more important than ever before. 

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