Passive ETF investors exposed to active-like risks

A surge in passive exchange-traded fund (ETF) indices might lead investors to being exposed to active-like risks as they might be making active investment choices without realising the performance impact, according to Zenith.

According to Zenith’s head of property and listed strategies, Dugald Higgins, this situation represented a paradox as ETF and other index-based funds were labelled as passive investments.

“However, we believe that any decision to concentrate exposure to a narrower group of stocks rather than the broad market index, should be viewed as an active choice,” he said.

Higgins stressed that such a decision might open up the potential for a performance and risk outcome that would be much different from the broader asset index, leaving investors surprised at the scale of difference.

Following this, Zenith’s analysis showed a wide dispersion of returns, particularly in the shorter time horizons while, in the long run, this would reveal an apparent cyclicality of performance where segments showed periods of outperformance followed by underperformance, relative to the broad asset class.

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“The high dispersion of results relative to broader market ETFs, both positive and negative, means that investors need to be discerning and disciplined in their investment choices,” Higgins said.

“What our research shows is that the pursuit of a more discrete index can certainly have merit. However, the outcomes compared to that achieved by broader exposures are highly variable.

“Success is likely to be underpinned by a robust index selection process that matches the investors’ requirements and using an appropriate investment horizon that allows the cyclical nature of returns relative to that of broader index-based ETFs to pay out.”