UCITS vs ETFs: The match!

The rise of derivatives over the past 20 years, which has accelerated over the last ten years, has put[5] the duel between UCITS and ETFs at the heart of the asset allocation debate. This opposition amounts to asking the question of who, active management or passive management, performs better?

In other words, is the active manager of a portfolio able to beat its target market, net of its operating costs and remuneration for the quality of its work?

The heart of the reflection lies on the theme of fees. The manager starts a long-distance race with two balls at his feet (the price of his management and the tools he must hold). Faced with it, the index replication algorithm requires a financial engineer and a model to implement. One thing is certain, it will replicate its market without beating it, but with very low costs.

Let's start by clarifying the concepts of active and passive management. This is an essential point because, in one case, we consider that the market is efficient and therefore cannot be beaten (passive management), on the other hand, the active manager considers that inefficiencies exist and can be exploited to do better than the market.

Passive management: ETFs (Exchange Traded Funds)

ETFs or exchange-traded funds are derivatives that are intended to replicate a benchmark. Thus an ETF[6] on the CAC 40 makes it possible to buy a basket of shares including the 40 values of the index. This ensures diversification on a given market or theme very simply.

ETFs derive their operation from the financial academic literature including Harry Markovitz's modern portfolio theory, which was supplemented with William Sharpe's asset valuation model (giving its name to the Sharpe ratio). In a very shortened way, theories consider that the market is efficient and that assets are permanently at market price. It would therefore be impossible to do better than the market since adjustments are made instantly on prices. Since investors are rational, they always favor the best return for the risk taken. In fact, the only solution to beat the market would be to take more risk. At given risk, the market is always right. Prices instantly reflect all the information available to investors.

This is of course a theoretical view that can be challenged in many ways, but it makes sense of our ETFs. They replicate the performance of the market effortlessly and it will not be easy to do better!

As such, historical data tend to confirm the hypothesis of a certain efficiency of the market with an outperformance of ETFs on active management. S&P measures this performance gap with its SPIVA research.

Over 10 years, here is the postulate in the USA:

  • 90.03% of actively managed equity[3] funds underperform the index.
  • 9.97% of actively managed equity funds beat the index.

Over 10 years, here is the postulate in Europe:

  • 87.81% of equity funds underperform the index.
  • 12.19% of equity funds beat the index.

The observation is eloquent and the figures deteriorate very strongly as soon as we spend 3 years of history. That is to say, very quickly. This explains the growing interest in ETFs.

However, active management has not said its last word. We will now deepen the concept and its operation.

Active management: UCITS (undertakings for collective investment in transferable securities)

A UCITS is a mutual fund that pools the money of several investors and uses it to invest in a diversified portfolio of financial securities (stocks, bonds, etc.). The portfolio is actively managed by a fund manager. Its goal is to beat a benchmark index where a target market.

Active managers are opposed to index management (passive, ETFs). Managers consider that markets are not always efficient because there are short-term price distortions. They are caused by unforeseen events, irrational investor behaviour or inefficiencies in the transmission of information. In addition, some information may be difficult to access or even hide, which could allow some investors to take advantage of this information to generate outperformance.

The manager will deploy strategies that take various forms: fundamental, quantitative, discretionary, systematic, mixed. The range is wide and the aim is to do better than the benchmark to which it is attached. The manager's main challenge is to ensure that the cost of implementing his strategy is less than the benefit he derives from it.

In other words, when we deduct the operating costs of the UCITS and therefore all the fees levied, does the fund manage to meet its ambition of outperformance? We had an answer with the SPIVA tracking report highlighting the underperformance of actively managed funds from 3 years.

In order to generate "alpha" (outperformance compared to the market), two major management schools coexist. On the one hand, the so-called "bottom-up" approach, which starts from the fundamental analysis of companies to create a portfolio of securities with criteria capable of doing better than the market. On the other hand, the "top down" analysis aims to start from macroeconomic analysis with a more global view to select the most promising stocks and sectors. There are also mixed approaches in which the two styles combine.

Although long-term performance statistics do not support active management, it should be noted that some funds manage to meet the challenge of outperformance in the short medium and long term. This proves that beating the market is still possible. The competitive advantage that the managers of these funds are able to derive is proven.

Here is an example of a French manager that we particularly like who does much better than the index of European equities as well as funds of the same category as his since its inception.

These are Romain BURNAND and the Moneta Multi Caps fund: (share C of private investors)

This fund is particularly interesting because it has no thematic or sectoral bias. In addition, it knows how to adapt to economic cycles and is positioned on the large-cap market, which has the particularity of being very efficient. Since 2006, the outperformance is more than 150%!

The main difficulty for the investor will be to identify the winners and to make a very fine follow-up to ensure that the management remains efficient over time.

Our point of view on active or passive management

We remain convinced, although inefficiencies exist, that markets remain globally efficient. This is particularly the case for markets in large developed economies and large-cap stocks. It is these geographical areas and the large companies that compose them that drain most of the interests of financiers. Financial stocks of major indices such as the S&P 500, Eurostoxx 50[2], CAC 400, FTSE 100 etc. are followed by armies of analysts, managers and large institutions. Information from large caps is everywhere and gaining a competitive advantage is very difficult. This is why very few active funds manage to outperform the US market and the S&P 500 index. This market is, so to speak, "too efficient" to achieve lasting competitive advantages over inefficiencies that a manager would be able to find. Information is sufficiently available and circulates too quickly. Only an increase in risk would make it possible to beat the market sustainably.

We can draw a similar conclusion in the investment grade[1] bond market (good rating). Efficiency is high (too much?) And the cost of implementing an active management strategy weighs even more heavily on good-rated bond yields (which are lower than equity yields). Beating the market for the target manager is a challenge.

So how do we take advantage of market inefficiencies?

To do this, you have to think outside the box. You have to go where the mass is not there. You have to go to the small and mid-cap market, emerging markets or high yield[4] bonds (high yield or low rating).

Indeed, these markets are less watched by the mass of players, analysts who follow certain stocks are sometimes very little or non-existent and in fact, gaining an advantage on the market by detecting valuation inefficiency, or by having additional information, is much more likely. From then on, a good manager will be able to do well by exploiting data sources and performing fine analysis to beat the market.

What is being put into practice?

Putting it into practice will depend on the strategy each investor wants to adopt. For a "buy and hold" investor who buys and decides to hold his investment over the long term by possibly strengthening his positions on a regular basis, the ETF strategy makes sense. This makes it possible without questioning to replicate the market and to have the certainty of beating a large number of managers in the long term. This is an approach that is also referred to as "lazy investing".

To try to be a little more tactician in portfolio management, we prefer to have a mixed approach. We find it interesting to build a solid portfolio base with ETFs in the main economic areas (Europe, US). This makes it possible to have a lower cost to have an exposure to highly efficient markets by ensuring that the performance is reproduced without deviating from it.

We can add to this an opportunistic approach by selecting UCITS in less efficient markets such as actively managed funds of small and medium-sized companies, high yield bond management or emerging countries. This selection will add a little risk to the portfolio while significantly improving returns.

Be careful, however, like any selection, you have to bet on the winners. Otherwise, the risk of the portfolio increases and its performance decreases… Yesterday's winners are rarely tomorrow's. A fundamental approach is to analyze macroeconomic parameters and valuation criteria to refine a selection.

This is where we come in to help you make your choices and build balanced portfolios that combine these approaches.

Termes et définitions
1. investment grade. L'expression "Investment Grade" (en français, "notation de qualité d'investissement") fait référence à la catégorie de qualité attribuée par les agences de notation aux obligations et aux émetteurs d'obligations.
2. Eurostoxx 50 ( Eurostoxx 50 ) L’Euro Stoxx 50 est un indice boursier qui mesure la performance des 50 plus grandes sociétés cotées à…
3. equity. Equity est un terme qui désigne une forme d’investissement à long terme dans une entreprise. Lorsqu’un investisseur achète…
4. high yield. L’expression “high yield”, en français “haut rendement”, est couramment utilisée dans le domaine de la finance et des…
5. put. Le “put de la Fed” n’est pas un instrument financier réel, mais plutôt une expression utilisée pour décrire…
6. ETF ( ETF ) Un ETF (Exchange-Traded Fund) est un type de fonds d’investissement qui se négocie sur les marchés boursiers, tout…
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