Passive vs. Active Management

Sometimes active management is better than passive management. Passively managed products, like exchange-traded funds, have their place in many portfolios, but they are not necessarily always the single best way to capture a desired effect or market exposure.

Last fall, the Morgan Stanley China A Share Fund (CAF - commentary - Cramer's Take) debuted. After a slow start, probably due to the time it took the fund management team to deploy the funds raised in the IPO, the fund has put in a very good showing when compared with the iShares FTSE/Xinhua China 25 Index (FXI - commentary - Cramer's Take) ETF.

It should be clear from the chart that while the China A Share Fund has wildly outperformed iShares FTSE/Xinhua China in the few months it has been trading, it has been much more volatile. The extra 25 percentage points are phenomenal, but depending on volatility tolerances, it has had some difficult periods.

Between Feb. 27 and March 5, the China A Share Fund was down 20% at its low point, compared with not quite 15% for iShares. Both funds have taken back most of what was given up during this run, but a 20% hit in one week is difficult to absorb.

One reason, perhaps the biggest reason, for the differences between the two funds is that they each pull from different markets. The China A Share Fund draws from the A market in China, which has trading restrictions in place. Morgan Stanley has been allowed access to this market.

iShares accesses Chinese shares that trade in Hong Kong. There are a few names that trade in both markets, such as PetroChina (PTR - commentary - Cramer's Take), a stock owned by both funds.

As of the most recent information from Morgan Stanley (dated Feb. 28), China A Share Fund's sector composition was dramatically different than iShares'. The largest sector in the China A Share Fund is the industrials at 31%, while it only takes up 11% in iShares. The financial sector is tops in iShares at 41% but only makes up 24% of the China A Share Fund.

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At the time of publication, Nusbaum was long China Mobile Ltd., China Petroleum & Chemical Corp. and iShares FTSE/Xinhua China 25 Index for client accounts, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.