Most active hedge fund managers will say “No”. However, recent data suggests that Hedge Funds are allocating more and more money into Index Exchange Traded Funds (or ETFs, for short). An ETF is very much like a mutual fund, or a basket of stocks/companies, which mimics a specific index. For instance, the most famous Index ETF would be the SPDR S&P 500 Exchange Traded Fund (SPY). This ETF is traded in the stock market and represents 500 companies that make up the S&P 500. There are many different ETFs ranging from sector ETFs, such as funds representing only the healthcare sector or technology sector, all the way to asset-class ETF’s (i.e. – Corporate bonds, Treasuries, etc.)
According to recent 13Fs – which are required hedge fund quarterly disclosure filings – actively managed funds held about $50 billion in ETFs, which is significantly greater than the amount of about $12 billion, held in 2007. Bridgewater Associates, which is known as the largest Hedge Fund to create the most billionaires in the world, holds about $10 billion in ETFs. This is about eighty-five percent of its equity holdings.
Many fund managers use ETFs to make bets on macroeconomic events. For instance, after Trump’s victory over the Electoral College in the 2016 election, fund managers placed a lot of money into the iShares Russell 2000 ETF. The Russell 2000 index represents the broader overall US stock market, including smaller companies…which are said to benefit the most from Trump’s lower taxation and deregulation policies. Because ETFs are so liquid and inherently diversified, fund managers love to get in and out of these investments as they see fit.
Active managers still argue about outperformance, and state that fund investors do not become super rich with passive indexing. Many of these hedge fund managers tout the likes of Warren Buffett, Mario Gabelli, David Tepper and Ray Dalio, as examples of how active managers can outperform the market by extraordinary margins. Unfortunately, most fund managers do not perform like a Warren Buffett or a Mario Gabelli. In fact, after deducting the high fees associated with actively managed funds, most of them underperform the overall stock market, and some of them underperform miserably.
What these fund managers say is somewhat true. It’s very difficult to get really rich through indexing. I mean if you look at the historical returns of the S&P 500, the index would have compounded your money at about twelve percent annually. This means $10,000 would take about forty-one years to reach $1.3 million. Forty-one years is a long time, and $1.3 million is not all that much money by today’s standards. However, what a lot of these fund managers fail to discuss is that there are leveraged ETFs. For instance, there are now ETFs that allow you to earn three times the returns of the S&P 500 index (on a daily basis). So, if the S&P 500 index goes up one half of a percent for the day, the ETF would yield a one and a half percentage gain. And if the S&P 500 keeps going up for multiple days, then the ETF would increase exponentially during the same time period. Of course, there is a downside – if the index goes down for the day, then the ETF will go down three times the amount. As we can see, triple leveraged ETFs are extremely risky and are not meant for long-term investing. However, we can see the potential of what ETFs can do.
For the more long-term minded investor, there are equal-weighted ETFs. These ETFs basically allocate their funds equally among all the companies in an index. For instance, the Guggenheim S&P 500 Equal Weight ETF allocates money equally among all 500 companies in the S&P index. In other words, the bigger companies will not receive more money than the smaller companies…which is very typical in ordinary index funds. Equal-weighted ETFs tend to outperform ordinary indexing because smaller companies tend to have more room for growth and, hence, yield greater returns over time. And because equal-weighted ETFs do not allocate less money to smaller firms, they tend to outgrow their ordinary indexing counterparts.