Another Thumbs Up for Index, ETF Investing

Tortoise_HareThe passive versus active management debate wages on, but a new report on 2011 performance gives more weight to index and ETF investing. According to the 2011 S&P Indices Versus Active Funds Scorecard (SPIVA), 84 percent of actively managed U.S. equity funds underperformed their relative S&P benchmark in 2011. About 80 percent of global bond funds underperformed their benchmarks last year.

But Srikant Dash, managing director, index research and design, S&P Indices, said the one-year numbers are not very meaningful because they can differ significantly from year to year. Instead, the long-term numbers are more informative, he said. But those also show active managers underperform. For the previous three- and five-year periods, about 56 percent and 61 percent of actively managed equity funds underperformed, respectively.

The question is, how much do advisors rely on manager selection anymore? Today, advisors are less focused on picking the right managers and more focused on asset allocation, Dash said. Asset allocation contributes to 85 percent of returns, while security selection accounts for 15 percent, he said. Other research shows it's even higher. According to Gary Brinson's research, roughly 95 percent of performance is derived from the asset class and not from the individual security selected. This shift has lead to the increased use of index products and ETFs.

“Advisors are more interested in understanding their clients’ liquidity needs, risk tolerance, and translating them into appropriate asset allocation, as opposed to picking the right managers," Dash said.

Using index and ETF products can zero out the active risk, he added. But in the past, one of the big resistances for advisors in using index products was the fear that these products could make them less relevant. They’re starting to realize that this is not the case, Dash said.

“The advisor’s role is more important in understanding the client’s risk tolerance, liquidity needs, funding needs, income, and factoring in the appropriate asset allocation,” Dash said. “That’s the more important piece.”

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