actively managed ETFs begin to attract investors

About 2 1/2 years ago, I first wrote about actively managed ETFs.

As I mentioned in greater detail then, for buy-and-hold investors ETFs can be substantially cheaper than mutual funds.  That’s because mutual funds maintain their own high-cost distribution and recordkeeping networks, while ETFs use the much larger, and cheaper, infrastructure maintained by Wall Street brokerage firms.  To pluck a number out of the air, the added value of the ETF route could be 50 basis points (0.5%) in annual return.

Active ETFs have never really taken off, though.  That’s partly because start-up active ETFs can be illiquid, and therefore difficult to trade.  And, again because of their small initial size, expense ratios can appear to be very high.  In addition, large mutual fund groups have been reticent to launch active ETF clones of their mutual funds.  Most firms don’t want to be pioneers.  But also, if an associated ETF begins to trigger redemptions of a mutual fund, the fund’s expense ratio will begin to rise–presumably creating more momentum to redeem.  That’s because the costs of distribution will be spread over fewer shares.

This may all be beginning to change.

As Factset reports, actively managed ETFs had large inflows for the first time ever in May.

Two things caught my eye:

–the Principal Financial Group launched an actively-managed, dividend-focused global ETF last month that took in $424 million, and

–ARK Investment Management, a small firm focused on “disruptive innovation”  received $37.3 million in new money in its flagship ARK Innovation ETF (ARKK) + the ARK Industrial Innovation ETF (ARKQ)  (Note:  I’ve owned ARKW, the firm’s internet fund, for a long time).  ARKK and ARKQ together had assets of $53.4 million at the end of April.

My first thought about the strong ARK showing was the attraction could be that the firm has been an early investor in the Bitcoin Investment Trust (GBTC).  But ARKQ doesn’t hold it.

It’s noteworthy, too, that Principal should want to cannibalize its mutual funds–although it’s always better to cannibalize yourself than to have other firms do it.


We may be at a positive inflection point in the development of active ETFs.  Good for innovation, if so.  Bad for stodgy mutual fund complexes, at the same time.


Wall Street strategists vs. analysts: S&P index and earnings forecasts

a little history

Pre-Great Recession, the peak for annual S&P 500 index earnings came in 2006, at $89.49.

The subsequent low, in 2009, was $60.78.

The index established a new earnings high in 2011, at $96.58.

2012 produced a 6.6% advance over 2011, at $103.04.

2013-14 earnings projections (all from Factset )


Wall Street strategists, who had originally been predicting virtually no earnings growth for the S&P in 2013, have grudgingly upped their estimate to $109.15, a year-on-year gain of 6%.  They’re penciling in a more substantial yoy advance of 9.2% for 2014, to $119.20.

Despite this positive news, they expect the S&P to decline from the current level over the coming year.


As I mentioned yesterday, both analysts and strategists have underestimated the earning power of S&P companies.  Analysts, who are usually the wide-eyed (over-)optimists, have been much closer to reality, but even they have fallen short in their prediction of S&P profit growth by a percent or so.

Analysts think the S&P will earn $110.36 in 2013 and 122.86 in 2014.  Those are gains of 7.1% and 11.3%.

As Factset interprets their calculations, analysts expect earnings reports to cause the S&P to rise as the market discounts them–by about 5% from here.

earnings growth by sector

According to Factset, analysts see sectoral earnings gains for the S&P for 2014 over 2013 as follows:

Telecom          +20.1%

Materials          +18.4%

Consumer discretionary          +16.5%

Industrials          +11.5%

S&P 500          +11.2%

IT          +11.0%

Financials          +10.1%

Staples          +10.0%

Energy          +9.7%

Healthcare          +8.9%

Utilities          +4.5%.

what strategists and analysts have in common

Both think that slow global economic recovery will continue.

Strategists expect very tepid upward movement in corporate until close to yearend, after which they expect the pace of growth to pick up.  Analysts are anticipating better near-term performance, but also with acceleration as the new year begins.

where they differ

1.  Analysts think earnings growth will be considerably better than strategists do.  If you look at the breakout of expected earnings performance by sector, you’ll notice that analysts are expecting economically sensitive areas to have the most robust earnings advances (note, in particular, Materials).  Energy prices will apparently be staying low–another plus for most world economies.   Defensive sectors will lag.

One caution:  analysts are always optimistic. Also, it raises eyebrows a bit if the bulk of the growth is several quarters in the future, where strong evidence is harder to find.  On the other hand, analysts have been right so far in being optimistic.  And it’s the strategists who are back-loading their growth forecasts.

2.  The more significant difference is that analysts think the market is going up; strategists think it’s going down.

Factset doesn’t give an explanation for this;  it just reports the numbers.

I don’t think this difference has much to do with earnings growth, though.  Strategists think the market’s price-earnings multiple is going to contract over the coming 12 months, even though they think earnings growth will accelerate.

Why would this be?  My guess is that strategists are thinking the Fed will begin to raise interest rates late this year or early next, and that this will cause the price investors are willing to pay for S&P earnings to shrink.

Tomorrow:  my take on all this.

where is the stock market headed?: Wall Street strategists vs. analysts

 Factset:  what Wall Street thinks

Last week I got a press release from Factset, a financial data collection and analysis service, on the topic of where the S&P 500 is headed over the coming twelve months.  The short answer from Factset:  brokerage house analysts think the market is going up a little bit, strategists think the market is going down–again by just a touch.

I’m going to write about this over the next few days.  My short answer:  if history is any guide, neither outcome is likely.  The market seldom drifts along.  It either goes up a lot, or down a lot.

strategists vs. analysts

Who are these people?

First of all, they’re both sets of “researchers” who work for brokerage houses.  Now, they don’t call brokers the “sell-side” for nothing.  The number-one job of any sell-side researcher–analyst or strategist–is to persuade customers to do their trading business with their firm.  In other words, they’re primarily salespeople.  That’s important because it means that at least to some degree they both tailor what they say to fit what their buy-side audience wants to hear.


Strategists are typically economists or statisticians by training, although they are also sometimes former portfolio managers (snide pms would probably say failed portfolio managers).

Strategists normally work “top down.”  That is, they use data about the macroeconomy to make forecasts about GDP growth and  the course of interest rates.  They then derive expected future earnings growth for the overall stock market and the price earnings multiple at which they think the market will trade.  That gives them a forecast of the future stock market price.  For the S&P over the next year, Factset says the strategists’ consensus is down, but my less than 10%.

Based on their analysis, strategists also recommend sector- and industry-based portfolio structure.  In conjunction with analysts, the may also suggecst individual stock holdings.  They may also help set policy–like the official forecast of the oil price–that analysts more or less adhere to in making their company earnings forecasts.

Strategists are normally much more conservative than sell-side analysts.  Their earnings growth projections are almost always lower than analysts’.  Clients occasionally permit strategists to be bearish, and–as is the case now–to say the market is headed south.  But a prolonged bearish tilt is almost like buying a ticket for the unemployment line.


Analysts are specialists in specific industries or economic sectors.  They may have academic training in engineering or other subjects pertinent to the industry they cover.  They may have worked in the industry, often in strategic planning or M&A.  They’re invariably deeply knowledgeable about company financials and about the competitive dynamics of their coverage. They often also have privileged access to the top management of the firms they analyze.

That access usually comes at a price.  Analysts can come under considerable pressure not to deviate–either up or down–from the official earnings guidance announced by these firms.  A “sell” recommendation can sometimes trigger a violent reaction from the company in question.

Many investors–childishly–don’t like to hear bad news about the companies they own.  At the same time, the analyst won’t earn much if he doesn’t have good things to say about at lease some firms in his industry.  As a result, analysts tend to err very substantially on the side of optimism.  They turn bearish, even for a short time, at their peril.

year-ago predictions

Industry analysts make projections of earnings growth and set stock price targets for the companies they cover.  They don’t make projections for the S&P.  Factset gets an implicit analyst forecast for the market by aggregating the analyst projections for each company in the S&P 500.

Getting a strategist forecast is much more straightforward.  Factset just takes a median.

Anyway, in April 2012 the implied analysts’ forecast for the S&P was much more bullish than the strategists–at +11.9% vs. +2.6%.

No surprise there.

What is a surprise (“shock” may be a better word), however, is that the analysts were a lot closer to the actual S&P 500 results of +13.8% (capital changes only).

year-ahead projections for the S&P

That’s tomorrow’s topic.

the dividend yield on European stocks? … 5.5%!!!

the MSCI Europe index yields 5.5%

That’s according to the analytic services company Factset, in a news release about a week ago.  Yes, the data are from the end of April, so they’re a bit dated and may be off slightly.  But, still…

Why so high?

1.  investor preferences

Historically, investors in European equities are much more income oriented than those in, say, US or Asian shares.  In fact, “growthier” European companies, which tend to plow back the cash from operations into expanding their businesses–rather than paying it out in dividends–may try to go public in venues like New York or Hong Kong instead of on their home ground.  Doing so gets them a more sympathetic/compatible audience, and therefore a higher price earnings multiple (meaning a lower cost of equity capital).

As a result, the European bourses are top-heavy with bank and telecom shares.  The former yield around 12%, the latter about 8%.

2.  the ongoing financial crisis has beaten down European stock markets…

…which have declined sharply over the past year.

Consider what current dividend yields in the EU are saying today:

–Two-year government bond yields in Germany and the Netherlands are currently slightly negative.  In both cases, you have to pay €1001 today in order to get €1000 back in July 2014.  Buying a telecom stock instead gets an investor an income pickup of over 8%–an extraordinarily high amount.

–Over the past ten years, the yield on the MSCI Europe index has averaged 4%  It has only been higher than today on one occasion–a brief period in early 2009, when panic selling of equities pushed the yield to 6.5%.

–The dividend yield on MSCI Europe is typically higher than that on the S&P 500.  The current 3.5% spread is, however, the widest gap seen in the past decade.

what does this mean?

On the most basic level, the numbers say to me that European equity investor confidence is completely shattered.  At the nadir for world stock markets in early 2009, German two-year bonds were yielding 1.5%.  The MSCI Europe was yielding 6.5%.  So the spread between the two was 5.0% then.

Today, the spread is 5.5%+.

Buying the MSCI Europe index, which would return 11% over two years, assuming no change in either stock prices or dividend payments.  Investors are choosing instead the safety of a German bond that they are assured of losing money on.

Put a little differently, the expectation built into today’s stock prices is that they will lose more than 11% over the next two years, wiping out the entire yield pickup–and more.  This would presumably come through some combination of dividend cuts and price declines.

Shades of Japan in the 1990s!

what to do

This view strikes me as excessively pessimistic.

Nevertheless, this doesn’t mean Europe is a screaming buy. The experience of Japan since 1990 may also be applicable here.

To my mind, there are several lessons that may be appropriate:

–although extremes of fear can’t be sustained, at least mildly negative views about equities can persist for a surprisingly long period, especially when the domestic investor base is relatively old and therefore particularly risk averse

–negative sentiment affects the prices of all stocks in a given market to some degree, not just the basket cases

–companies whose main virtue is their high current yield are probably not going to be the big relative winners.  In my view, and also the way I read developments in the Japanese market over the past twenty years, the real winners are well-managed companies which are growing quickly and whose profits come mainly from non-domestic (meaning, in the case of Europe, non-EU) sources.  Better if they pay a current dividend, but the rate of earnings growth is more important.

Feeling for a bottom in Europe is not a task for the faint of heart.  Nor is it anything one should do with more than a small fraction of his portfolio.  Still, it seems to me that we’re at, or near, a degree of negative sentiment that’s excessive and can’t be sustained for long.