ETF or fund? Six tips for making the right choice

More and more investors are swearing by cheap index funds. But that doesn't mean actively managed funds no longer have a future. How should you choose and what can we learn from award-winning funds?

On Thursday, De Tijd & L'Echo presented awards to the best-performing investment funds on the Belgian market for the 30th consecutive year. In recent years, they have generally managed to outperform the reference index. However, the number of funds that outperform the index remains globally in a minority, and past performance offers no guarantee for the future. Still, the winners offer some lessons that can help you select an active fund.

1. Decide where to invest

Biennial research reports from S&P and Morningstar show that it's easier to beat the market in some categories than others. The Morningstar report shows that 11.4 percent of actively managed equity funds outperformed their market over the past ten years. For active bond funds, that percentage was 31.5 percent over the same period.

There are also differences within those categories. Among funds that invest exclusively in US large caps, stocks of companies with a very high market value, no fund performed better than the index over a period of ten years. In contrast, almost half of Chinese equity funds performed better. So in the first category, you might be better off with an ETF, a passively managed investment fund that mimics the performance of an index and is traded on the stock exchange. But in the second category, you can benefit by choosing an actively managed fund.

A general rule cannot be deduced from success rates, but active management usually scores better in less efficient markets, where fewer analysts monitor stocks. Active management also scores better in highly concentrated markets, where index heavyweights are not doing as well.

The growth markets are a good example of often less efficient markets. The US bond specialist Pimco won a Time Award in the growth market bond category this year by mainly exploiting inefficiencies in less followed segments of the growth markets.

“Today, there are already more than 80 countries in the growth market bond category that can be invested in. That's more than doubling in a few decades,” says Pimco. “In addition, the number of investable bonds increased twentyfold over the same period. So the offer is huge. Thanks to our large team, we can take many more smaller positions. Smaller teams have the problem of having to focus on the countries they know better. '

2. Avoid cuddlers

Regardless of which category you want to invest in, avoid cuddlers. These are funds that hardly differ from their reference index. These funds will offer comparable gross returns compared to their passive counterparts, but after costs, you are better off with the cheaper trackers. ETFs are therefore always the best choice here.

You can recognize index cuddlers in various ways. For many funds, you can find the “active share” on the product sheet. This is a percentage that indicates the extent to which the fund differs from the index. The higher the percentage, the more active the fund. For example, Lazard Emerging Markets Equity, winner of the award in the growth market stocks category, has an active share of 81 percent. This means that the fund only has 19 percent overlap with the index.

If the active share is not on the sheet, you can also compare the fund's largest ten positions with those of the index. If there are few differences, you may be dealing with such a cuddler.

What is even more remarkable is that really active managers often dare to take strong positions (conviction), investing in only a limited number of positions. They then gain a relatively large weight, so that the largest ten positions quickly take over 30 percent of the fund. Of the five equity funds that won an award, three invested in only 50 to 60 stocks.

By the way, deviating from the index does not necessarily have to be done with a concentrated portfolio. Highly diversified portfolios can also differ significantly from the index. We see this more often with fixed income funds. Rothschild & Co Asset Management, which won in the euro corporate bond category, has no less than 313 positions in its winning fund.

3. Note the costs

An important criterion when choosing between a fund and an ETF is the costs. The more costs active funds charge, the higher their return must be to come close to the tracker's return after those costs. So be careful with funds whose annual costs are considerable.

However, there are exceptions that confirm the rule. Indépendance Europe Small, a fund that invests in European small caps and is managed by France's Indépendance AM, charges 2.11 percent annual fees. But the fund's performance, after those costs, is solid. Over the same period, it achieved an average return of 18.5 percent per year, while the reference index achieved a return of 5.3 percent per year over the same period. You should therefore look at the costs in relation to the performance presented by the funds. By the way, recurring costs are automatically included in the inventory values of the funds, and thus in the returns they report.

4. Avoid cowboys

The return is one thing, the risk that fund managers take to achieve that return is another. A good way to look at that risk is how the fund performs in bad stock market years. It is also a criterion for awarding the awards. Those who want to do that research themselves can simplify the exercise by looking at the fund's performance in a crisis year. If it does significantly worse than the reference index in such a year, it usually means that you are dealing with a fund that takes more risks or uses a riskier style.

For example, Pimco Income Fund, a globally diversified bond fund, pays a lot of attention to risk control. In 2022, it had hedged itself very well against the sharp rise in interest rates that occurred then, among others, in the United States. While the benchmark index lost 13 percent that year, the fund was able to limit the damage to 7.5 percent.

The volatility, which is often included in the fund sheets, is also an indication of the risk that the fund takes. The higher the volatility and the more it differs from that of the reference index, the greater the price fluctuations and therefore the more risk.

Preferably choose managers with a disciplined investment process that eliminates emotions no matter what happens on the stock markets. As an investor, it is not easy to know how much a manager has that property based on investment policy, but sometimes it is obvious. In the European equities category, a quantitative fund from BNP Paribas Asset Management became the winner. Quantitative funds are funds that are compiled based on mathematical models. Emotions are thus turned off.

5. Opt for dedicated administrators

Managers who invest in their own funds themselves have a greater commitment than managers who do not. Unfortunately, there is no European obligation for administrators to report on this. Investors are therefore usually unaware of it. Of the 14 award-winning funds, no less than nine are whose managers invest in their own funds, according to a survey. At Mercier Van Lanschot, the winner in the mixed funds category, that “skin in the game” is even crucial. “We attach great importance to our 'investing together' philosophy. By investing with our customers, you manage a fund differently,” says manager Eun Ah Schittekat.

Another form of commitment can also result from the cost structure. Some funds have performance costs, which can only be charged if the fund achieves a pre-determined performance. These performance costs align the interests of the manager and the investor: both benefit from a high return.

But beware: be sure to check whether this does not cause the overall cost level to rise too high. If the fund already charges high annual costs and, on top of that, a substantial performance fee, the bill rises too much. The performance fee is then more a bonus for the manager than a fair way to charge the investor.

6. Don't be dazzled by star admins

The success of a fund is often attributed to one so-called star manager. But blindly trusting that person is not a good idea. History shows that they too can fall off their pedestals.

After all, they face a lot of pressure. In order to maintain their performance, they sometimes seek more risk. For example, British star manager Neil Woodford changed his shoulder by investing more in smaller, unlisted companies. They offer the prospect of higher returns, but are not liquid. When investors wanted to leave the fund after disappointing results, it turned out that Woodford could not repay them because he couldn't sell those illiquid investments quickly enough.

Sometimes stardom leads to overconfidence. The managers then dive into a new market because they are convinced that they will succeed there too. It happened to Anthony Bolton, who, as a contrarian value investor, had built up an impressive status with a British equity fund with Fidelity. In 2007, Bolton retired, but in 2010, he returned to play the Chinese growth story with a Chinese equity fund. Bolton had first visited China in 2003, did not speak the language and had no plans to learn it. His Chinese story ended unsuccessfully in 2015.

Overconfidence also killed Bill Miller, a successful US fund manager. His Legg Mason Capital Management Value Trust fund beat the S&P500 index every year from 1990 to 2005. Miller was a value investor who dared to bet heavily on undervalued companies with strong business models. But in the years before the financial crisis of 2007-2008, he wrongly gambled that housing and the financial sector, which were already under pressure at the time, would not fall further. It killed him. In 2008, his fund lost 55 percent.

Another danger looms if the manager's fund becomes too large, so that he can no longer use his strategy in the same way. For years, Bill Gross was the largest bond manager in the world. His Total Return Fund has consistently outperformed its rivals. But in 2011, he fell from his throne due to poor performances. Gross said his fund had fallen victim to its size. Eventually, he left Pimco and ended up with Janus, where he stopped breaking pots.

Past success therefore offers no certainty for the future. Even with award-winning funds, you have no conclusive guarantee of future success. But if you start from a fund with a consistent investment philosophy and a good track record, you will increase your chances. Although it is important not to sit back, but to monitor the fund at least annually.

If there is a good explanation for a disappointing year, you don't need to take action right away. But if a fund starts to deviate from its investment philosophy, starts taking more risks, or starts charging higher fees for no reason, it's time to act. Investing in active funds therefore also requires some active management from the fund investor. If you don't want to pay that, it's better to opt for an ETF.

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References

• Source: De Tijd
• Link: https://www.tijd.be/markten-live/fondsen/algemeen/etf-of-fonds-zo-maakt-u-de-juiste-keuze/10652262.html
• Authors: Peter Van Maldegem
• Photo: Filip Ysenbaert.
• Date: 13/03/2026