'Active in drag,' a funky riff for index fund investors
By Trevor Hunnicutt
NEW YORK Aug 7 (Reuters) - As investors pour more and more money into funds that track indexes, the indexes themselves are getting more esoteric.
Challenging the very definition of "index," companies that construct these benchmarks are slicing and dicing the market in innovative ways.
Some strategies of late include funds which favor low-volatility or high-dividend securities instead of conventional products that track benchmarks like the S&P 500, which give greater weight to firms with bigger market values.
The latest in a series of products competing with traditional benchmarks is the Equal Risk Weighted Large Cap exchange-traded fund, launched by Connecticut-based VelocityShares launched last month. It re-balances the S&P 500 by assigning new weights to benchmark components to spread risk.
Welcome to the space between active and passive portfolios, also known as "active management in drag." These sometimes-funky benchmarks allow passive investors to make choices that can result in completely different bottom-line returns, leading to the view that these investments are not quite passive.
Passively managed funds are designed to mirror the performance of an index, with its component securities chosen in generally the same proportions as the index it tracks. Active fund managers use discretion in making trades in order to outperform a benchmark index. The risks of alternative indexes include the possibility of under-performance.
No one can classify what percentage of indexed portfolios exist in this realm. So far this year, $29.1 billion has moved into benchmarked ETFs that deviate from cap-weighting, a quarter of the $115.5 billion that flowing into ETFs overall in 2013, according to data collected from XTF, an analytics firm.
"It's creating a third way of investing between passive and active," said Brett Hammond, managing director at MSCI Inc , a major index provider behind some 500 exchange-traded funds. Continued...