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Portfolio construction

Do smaller asset ETFs offer a performance advantage?

April 03, 2024 - 3 min read

There’s a long history of asset management experts talking about whether, on average, smaller exchange-traded funds (ETFs) and mutual funds perform more strongly than larger competitors.

It’s been a debate going back at least 30 years, when I first entered the financial services industry. However, is it true or is it simply perception? There’s no definitive answer without caveats – at least not one that I have uncovered – but there are theories.

 

Do smaller asset ETFs have more flexibility to try new things?

Could it be that smaller asset ETFs (in my mind, those with $250M or less in assets, but others could define this differently) are nimble and better able to take advantage of market dislocations and other opportunities quicker than larger asset ETFs?

One example refers to the speed to get to optimal allocation. Can smaller asset ETFs move quicker to get fully invested in a target company? A larger asset ETF may take a longer time to trade to their targeted position because of a fear of moving markets if they trade too much of the average daily volume (ADV).

Additionally, could it be that small asset ETFs might take more aggressive positions in their top ideas, being bolder about the risk of asset loss if they make a mistake? Some larger ETFs might be more cautious about the performance risk and perception risk of a bad security purchase that strays far from their benchmark weight. If a given buy goes wrong for the larger asset ETF, there could be substantial management fee revenue at risk if investors redeem the ETF en masse.

 

Does innovative thinking help smaller asset ETFs outperform?

Do smaller asset ETFs more strongly represent the latest innovative thinking from asset managers and, as a result, some of the best ideas available? Could that be why these smaller asset ETFs might outperform?

Certainly, more well-established, large asset ETFs can be innovative too, and make changes to the way they invest or structure the ETF, but some of these changes might require time-intensive and costly proxy activity. Applying innovative thinking to a new, small assets ETF would come without proxy requirements, if done at the time of the launch.

 

A closer look at the data between small and large asset ETFs

I decided to test this hypothesis against performance-backed data. I looked at a sample of actively managed ETFs that are defined by Morningstar as US Large Growth, US Large Blend, and US Large Value, and compared their 1-year trailing return through 2/29/24 against each ETF’s prospectus benchmark.

I divided the custom universe into two categories: ETFs with more than $250M in assets and ETFs with less than $250M in assets. The data can be explored in different ways (such as having another definition of “small,” but in my particular study, the smaller ETF cohort had more ETFs beating the index, while the larger ETF cohort had a higher win-rate. Also to note, there is a natural survivor bias in the large cohort, since many underperforming newer/smaller ETFs might be liquidated, before they ever have a chance to enter the large cohort.

Source: Morningstar Data, as of 2/28/24. Excludes ETFs with less than $3M in assets. Excludes ETFs without a Morningstar provided benchmark in the dataset.

 

To date, I haven’t seen conclusive research indicating there’s a right or wrong answer on this topic. I also don’t think one could prospectively use this idea of a “small asset advantage” with precise accuracy. However, it’s an interesting topic to contemplate when making choices between smaller and larger asset ETFs.

Before investing, consider the fund's investment objectives, risks, charges, and expenses. Visit im.natixis.com for a prospectus or a summary prospectus containing this and other information. Read it carefully.

An exchange-traded fund, or ETF, is a marketable security that tracks an index, commodity, bond, or a basket of assets like an index fund. ETFs trade like common stock on a stock exchange and experience price fluctuations throughout the day as they are bought and sold. Short-term fixed income ETFs invest in fixed income securities with durations between one and five years.

All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, money market, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.

The views and opinions expressed may change based on market and other conditions. This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary.

Unlike passive investments, there are no indexes that an active investment attempts to track or replicate. Thus, the ability of an active investment to achieve its objectives will depend on the effectiveness of the investment manager.

Diversification does not guarantee a profit or protect against a loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Asset allocation does not ensure a profit or protect against loss.

ETF General Risk: ETFs trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are not individually redeemable directly with the Fund, and are bought and sold on the secondary market at market price, which may be higher or lower than the ETF's net asset value (NAV). Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns. Active ETF: Unlike typical exchange-traded funds, there are no indexes that the Fund attempts to track or replicate. Thus, the ability of the Fund to achieve its objectives will depend on the effectiveness of the portfolio manager. There is no assurance that the investment process will consistently lead to successful investing.

ALPS Distributors, Inc. is the distributor for the Natixis Gateway Quality Income ETF, the Natixis Loomis Sayles Focused Growth ETF, and the Natixis Vaughan Nelson Select ETF. Natixis Distribution, LLC is a marketing agent.

Natixis Distribution, LLC is a marketing agent. ALPS Distributors, Inc. is not affiliated with Natixis Distribution, LLC.

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