In the ETF industry, investors generally group ETFs into one of two categories; passively managed or actively managed. Passive funds follow indexes, while active funds pick and choose securities for selection in a portfolio.
While active funds might beat the market, these funds are usually associated with higher costs, which at times are not justified (read: 7 ETFs to Buy in 2014). Still, those that outperform can make those extra costs well worth it for many investors in the market.
A Better Way?
A third way of investing in the ETF space is through ‘enhanced’ index ETFs. These funds follow the ‘middle path’ tracking an index that is a bit more active than many of its counterparts. Overall, these indexes attempt to select stocks that have better chances of risk-return performance, based on certain fundamental characteristics or a combination of such characteristics.
One such strategy that appears well suited for this approach is tracking money managers and their investments. All star managers can drive stocks higher, and following their techniques might be a way to outperform the broad markets.
One way to do this in the ETF world is with the Global X Top Guru Holdings Index ETF (GURU - ETF report) . This fund has returned an excellent 42.52% in 2013 compared to 26.5% for SPDR S&P 500 (SPY - ETF report) .
Below, we highlight some of the key reasons for this outperformance, and why investors might want to consider GURU as a potential outperformer in 2014 as well:
GURU in Focus
Launched in June 2012, the fund has gained popularity and has attracted $402 million so far. This fund permits retail investors to gain exposure to popular long-term focused market gurus via the ETF route, which was previously accessible to only wealthy investors.
The fund aims to generate alpha vs. benchmark equity indexes and rebalances quarterly.
GURU uses a proprietary methodology to compile the best ideas from a select pool of hedge funds where the 13F information is most valuable (read: Beat Hedge Funds with These ETFs).
(All hedge funds with more than $100 million in U.S. equity investments are required to publish their holdings in a publicly available document called the 13F.)
Moreover, GURU only focuses on longer-term holdings and funds with lower turnover, targeting only the highest conviction stock picks, suggesting this fund could be a winner again in 2014.
Thus, GURU is one such ETF that looks for the best investment ideas from these holdings and replicates them. In other words, investing in the top holdings of the most sophisticated hedge fund managers enabled the fund to soar, and easily beat the market in 2013.
The fund holds 54 stocks in its basket and uses equal weight exposure that keeps the portfolio balanced across various companies, hence it avoids concentration risk. As such, none of the stocks within the portfolio comprise more than 2.5% of total assets.
The fund seeks to track the performance of SolactiveTop Guru Holdings Index. Currently, the top three holdings for this includes Sprint Corp, Hertz Global Holdings and Cumulus Media.
GURU charges 75 basis points a year, a little higher than most ETFs. However, the fees are often lower than what investors have to pay in the ‘true’ hedge fund space.
Though the fund has delivered stellar returns since its inception there are some pitfalls in implementing a hedge fund replication strategy. Firstly, GURU may hold securities that are outdated.
Hedge funds have approximately 45 days after the end of each quarter to disclose their holdings. Thus it might happen that a given hedge fund might have offloaded its position in the stock by the time of the 13F filing.
Moreover, as hedge funds are required to disclose only their publicly-traded stock positions, GURU might not necessarily reflect all the strategies used by the hedge funds.
To sum up, GURU’s superior stock selection methodology and its reduced risk exposure due to diversification benefited the fund to outperform in 2013 (read: Best ETF Strategies for 2014).
Thus, if markets continue to move northwards, this fund might be an excellent pick for investors looking to replicate the portfolios of some of the biggest long-term focused money managers in the world.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report >>