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ETFs vs Hedge Funds – Off to Le Mans

In the 1960s, Ford Motor Company, the large-scale manufacturing car company decided to compete against Ferrari, the luxury sports car giant, in the annual sports car race at Le Mans, France. The legendary endurance race was considered a race that tested both speed and innovation in fuel-efficient vehicles and is now entertainingly told on celluloid in the new movie, Ford v Ferrari[1] (titled Le Mans '66 in the UK and other territories). History is full of famous rivalries and so too is the investing world – with Exchange Traded Funds (ETFs) now at the front of the pack. Alongside the active passive race, investors have been focused on the ETF vs Hedge Fund AuM race and it will be one indicator of whether the industry ends up in a Barbell or Bell Curve[2] shape.

Let the race begin

Long seen as the Ferrari of the Fund world, Hedge Funds were able to charge a “2 and 20” model – 2% management charge and 20% performance fee for investors seeking premium alpha and superior returns. However, as their luxury status attracted more attention, capacity constraints and copycat imitations led to decreased quality. With more people chasing the same market anomalies, it became harder to beat the market. Hedge fund managers are paid on results, and as performance dwindle, so does pay. Long hours, high turnover, poor work life balance is draining the talent from the industry. As investors focus more on fees, “1 and 30” becomes the new “2 and 20”, but what the industry really needs are fee structures and compensation schemes that align managers with the incentive to act in the best interest of the investor.

ETFs, the low profile, hard-working, non-sexy, low cost fund vehicles, slowly built ground and began to attract attention from investors by charging average fees below .50%. Like the concept introduced by Henry Ford, known as Fordism[3], ETFs, industrialized the production of fund strategies for mass consumption through scale, efficiency and transparency. In 2015, ETFs surpassed the Hedge Fund industry leading the race to $3tn AuM (ETFGI and Hedge Fund Research). As investors focus on the main headlines, some interesting sideline races are coming to the fore around Private Assets and Structured Products – these are interesting topics marketßeta will be monitoring.

Check your speed

ETFs, first launched in the 1990s, took only 25 years to get pass the $3tn AuM mark, whereas it took 66 years for Hedge Funds to grow to $3tn AuM in 2015. As equity-oriented Hedge Funds continue to lag the market, liquidations continue to outpace launches over the last 3 years (Hedge Fund Research), with many well-known funds dropping out of the race[4]. As global ETFs/ETPs surpassed $6tn AuM in 2019 (ETFGI), projections of $12tn AuM by 2023 (Blackrock) are not unreasonable. However, quietly in the background, structured products, at $7tn AuM (Bloomberg), are on the rise again as investors seek more outcome-oriented solutions with downside-risk protection. With a 10-year CAGR of 20% and YTD 2019 growth of 27% (ETFGI, Nov 2019), critics talk about ETFs “devouring capitalism”[5]. But are critics missing the black hole of Private Assets, such as private equity, venture capital, infrastructure, real estate and private debt? According to Preqin and EY[6], globally, Private Equity is estimated at $3.4tn AuM, up from less than $500bn in 2000. Across all Private Assets, the total is more than $6tn AuM. The rise of Private Assets and the decline of public listings will have a much greater impact for investors, specifically retail investors, and capitalism.

Staying in your lane?

The technology and adoption that democratized ETFs are now heading its way to take on the rest of the world, including Hedge Funds, Structured Products and Private Assets. The proliferation of indices and availability of real-time data means ETFs can structure and mimic previously restricted, alternative alpha strategies. The coming developments around non-transparent ETFs means Active managers are becoming more comfortable with the ETF structure. However, wrapping a fund strategy in a different chassis doesn’t change the underlying engine. It is always essential for investors to look under the hood and focus on value for money. Why pay for a Ferrari, when you just need a Ford? Is your car still fit for purpose as governments outline their “Road to Zero”[7] policies?

Crossing the finish line

Ford took the crown from Ferrari at Le Mans ‘66, but neither of them have been seen with the crown over the past 20 years. History is full of famous rivalries, and it’s not the winners or losers that we ultimately care about, but the competition that gives rise to innovation. The automobile industry is pivoting towards sustainability (electric engines), alternative distribution (flying autos), artificial intelligence (driverless cars), and new fee structures (car subscriptions and on-demand payment), all the while dealing with tougher regulations and intense competition from emerging industries. The investment industry has a lot of catching up to do. For investors who want to participate in automobile industry growth, there are a few ETFs currently offering exposures to electric vehicles and innovative driving technology.

We at marketßeta are keen to watch this race and want to do more than just sit on the sidelines, what about you?

[1] “Ford vs Ferrari”, 2019.

[2] “Barbell or Bell Curve”, Graeme, Yang, 2019.

[3] Fordism is a term widely used to describe (1) the system of mass production that was pioneered in the early 20th century by the Ford Motor Company or (2) the typical postwar mode of economic growth and its associated political and social order in advanced capitalism.

[4] 2019 saw the closures of well-known and established Hedge Fund managers, with Moore Capital and Stone Milliner amongst the 540 funds that have liquidated YTD Q3 2019. This is on-pace to exceed 2018 liquidation of 659 funds. Q3 2019 represents the fifth consecutive quarter in which liquidations exceeded launches, according to Hedge Fund Research Market Microstructure Report (Dec 2019).

[5] “ETF growth is ‘in danger of devouring capitalism’”, February 2018.

[6] “A new equilibrium: Private equity‘s growing role in capital formation and the critical implications for investors”, October 2019, EY.

[7] In 2018, the UK government pledged that half of all new car sales will be hybrid or electric by 2030 as part of its “Road to Zero” plan to reduce vehicle emissions.


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