Here’s an interesting exercise: Ask yourself what domestic equity sectors have fared best this year.
If you use the Select Sector SPDR ETFs as your benchmarks, you’ll end up with results like these:
As you can see, seven sectors have outdone the broad market this year, with technology (XLK) and health care (XLV) topping the list. Keep in mind that these sector ETFs represent passive investments. They’re index trackers, so earning 14 or 12 percent in a 9 percent world ain’t half bad.
But then, consider the opportunity that the current market provides. See the chart below? The red line represents the CBOE S&P 500 Implied Correlation Index (KCJ), a metric derived from option prices that indirectly tracks the opportunity to earn alpha. The lower the index goes, the less the S&P 500 is correlated to its larger component stocks and the greater the chance for stocks to over (and under) perform.
KCJ has plummeted this year. As 361 Capital portfolio manager Blaine Rollins puts it: “The environment for uncorrelated returns is very good … active investors do not have excuses in 2017.”
So, do active ETF managers have any excuse? Have they been able to outdo XLK and XLV this year?
It doesn’t take much effort to find out. There are only 197 active ETFs in the Morningstar database. Only three are identified as technology funds and just one is a health care portfolio. And you know what? All of them are managed by the same outfit. ARK Investment Management runs two index ETFs alongside the four thematic active portfolios listed below.
All the ARK funds have wide mandates to invest in disruptive technologies. The ARK Innovation ETF (NYSE: ARKK), while not a fund-of-funds, invests in the three themes pursued by its sister funds.
This year, ARK's wagers have paid off handsomely. Each of the funds handily outperformed its SPDR benchmark. Such was not always the case, however. Since the funds were launched in 2014, only the ARK Web x.0 ETF (NYSE Arca: ARKW) has actually earned positive alpha.
The ARK portfolios clearly have the wind at their back this year. Volatility is their bugaboo, though. See the impact beta has had on alpha? The ARKW portfolio is the only one with a below-market beta and the only one with a positive alpha coefficient.
The lesson here? There are times when alpha can be sought most efficiently. Now is that time, but times change. When the correlation index begins to rise, alpha will be even harder to harvest. Keep an eye on it.
