The first exchange traded funds aiming to cash in on the puzzle of the “night effect” launched in the US on Tuesday.

Academic research has shown that most of the gains chalked up by Wall Street actually happen overnight while the market is officially closed, amid the sparse after-hours trading that occurs on some electronic exchanges.

The same mysterious phenomenon has been noted in a range of other countries, from Japan to Norway.

NightShares, a new ETF provider based in California, is launching funds designed to give investors a straightforward way to tap into this nocturnal trend.

“Though the outperformance of overnight markets has been identified and documented by a large body of research for some time, until now there has not been a simple way for ETF investors to capture the value of this phenomenon,” said Bruce Lavine, chief executive of NightShares and a former iShares and WisdomTree executive. “This is some of the most compelling research I have ever seen.”

Data compiled by AlphaTrAI, a sister company of NightShares, suggest the impact of the night effect is most compelling for smaller companies. As of the end of March, the iShares Russell 2000 ETF (IWM) had returned a cumulative 262 per cent during the night time since 2012, but had lost 26 per cent during official US trading hours.



The large-cap iShares Russell 1000 ETF (IWB) delivered cumulative night-time returns of 200 per cent over the same period while its daytime returns were just 19 per cent, according to AlphaTrAI.

Moreover, the larger overnight returns have not been accompanied by increased risk, as volatility has tended to be slightly higher during the day.

The causes of the night effect anomaly remain a mystery, with little agreement on an explanation among academics and analysts.



Max Gokhman, chief investment officer of AlphaTrAI Funds, believed the release of corporate news after the market close was a factor as earnings statements and mergers and acquisitions activity announced in the evening tended to be positive for stock prices more often than negative.

Gohkman also suggested there was “a big structural desire among institutions to de-risk overnight and re-risk in the day”, artificially pushing prices down at the close and raising them at the open.

This may be driven by “the illusion of control”, with traders confident that they can trade their way out of a problem if the market is open, but not when it is closed.

“They think it’s better to have their hand on the throttle than let the autopilot take over, even though the autopilot is safer,” he added.



Traders may also have to pay interest and capital charges overnight, whereas “if you are out by the end of the day you don’t have to deal with any of that”, said Gokhman.

Moreover, higher volatility during official opening hours may be driven in part by the “large community of day traders that add a lot of noise in the day and go home at night flat”, after squaring their positions.

Lavine claimed most of the “really nasty downturns” have occurred during official market opening hours, even though these last for just 6.5 hours a day.

Exiting the market at the opening bell every day and buying back in at the close inevitably drives up trading costs, however.

NightShares is aiming to minimise trading costs by using index futures contracts. The ETFs will hold their assets in cash and Treasury bills rather than the underlying equities. Lavine said the income generated from this approach would offset the “great majority” of ETFs’ trading costs.

Its first two ETFs, the NightShares 500 ETF (NSPY) and the NightShares 2000 ETF (NIWM), will target the night performance of portfolios of 500 US large-caps and 2,000 US small-caps respectively, analogous to the S&P 500 and Russell 2000 indices. Both have an expense ratio of 0.55 per cent.

NightShares has also filed to launch 1.5 times leveraged versions of NSPY and a similar product based on the tech-heavy Nasdaq 100 index.

Todd Rosenbluth, head of research at VettaFi, a data provider, said NSPY could have a role as a long-term buy and hold complement to SPY, or as a short-term tactical trading tool.

“There are [already] investors trying to trade after hours, which is a relatively illiquid market, so this provides an opportunity for them,” Rosenbluth said.

“This could be used tactically by an investor who saw the market sell off at the close but who believed it would recover the next day.”

However, Kenneth Lamont, senior fund analyst for passive strategies at Morningstar, sounded a note of caution about the ETFs’ potential to generate alpha, or outperform the wider market.

“If it was a bankable alpha-generating opportunity then you would presumably see it disappear really quickly,” Lamont argued, with the likes of hedge funds stepping in to arbitrage it away.

“I would hazard a guess that the after-fees performance of these funds will be less impressive than the backtested data,” he added.

“Many of these niche alpha-generating products, when they are let loose into the wild of real markets, tend to be somewhat underwhelming.”

Asset manager Fidelity plans to roll out a direct indexing tool in the US that will require investment of as little as $1 per stock, in a significant move to open up the concept to small investors.

The direct indexing concept, which allows investors to create bespoke portfolios tailored to their personal preferences, is widely seen as a long-term threat to traditional pooled vehicles such as mutual and exchange traded funds.

Once limited to wealthy investors, Fidelity’s move is the latest sign of direct indexing expanding into the mass market, particularly in the US.

The Fidelity Solo FidFolios platform will carry a monthly fee of just $4.99. It will allow investors to create custom indices, either by building one from scratch or selecting one of 13 Fidelity thematic stock models. Investors can then customise the models by adding or removing stocks or adjusting their weights.

The available thematic models are cloud computing, cyber security, 5G “future connectivity”, electric vehicles, clean energy, fintech, digital health, biotechnology and drug discovery, staples, utilities, real estate investment trusts, “quality” income and robotics and artificial intelligence.

The models contain ordinary stocks, American depositary receipts and preferred securities, according to the Solo FidFolios website. Foreign stocks, options and other non-equity securities such as ETFs and mutual funds, will not initially be available.

The new platform, which Fidelity plans to roll out “over the coming weeks”, will allow users to rebalance, purchase and redeem an entire portfolio of stocks with a single click, Fidelity’s announcement said.

The Boston-based manager said the growing field of direct indexing was the next “game changer” for retail investors.

“The introduction of mutual funds was a game changer for the average investor, allowing them to gain access to financial markets once only the wealthy had access to,” Fidelity said. “Then ETFs came along and helped with diversification and potential tax efficiencies with intraday trading. What’s next? Direct indexing.”

The direct indexing space has seen explosive growth in recent years, as many shops have been eager to scoop up firms with the technology to provide the service.

In January, UBS announced it would buy robo-adviser Wealthfront for $1.4bn. Wealthfront’s tax-loss harvesting and direct indexing technology were key motivators for the acquisition, Kirt Gardner, then UBS’s chief financial officer, told analysts in February.

In December, BNY Mellon’s Pershing announced that it would buy direct indexing provider Optimal Asset Management and fold the tool into the new Pershing X unit, which aims to manage “multiple and disconnected technology tools and data sets”.

In other recent deals Franklin Templeton acquired O’Shaughnessy Asset Management, a $6.4bn quant shop that runs a direct indexing platform; Vanguard scooped up direct indexer Just Invest; and JPMorgan Chase bought custom indexing provider OpenInvest.

During the next five years, direct indexing will expand at a faster pace than mutual funds and ETFs, according to an August report from Cerulli Associates.

Assets are expected to grow at an annualised rate of 12.4 per cent, faster than the projected 11.3 per cent growth rate for ETFs and 3.3 per cent for mutual funds over the same period, according to Cerulli.

In October Seth Bernstein, chief executive of AllianceBernstein, called direct indexing a “real opportunity” that will continue to grow.

Fidelity’s new service is available as an “enhancement” to its existing brokerage accounts. There are no account fees or trade commissions.

In April it rolled out Fidelity Managed FidFolios, a direct indexing platform that requires an investment minimum of $5,000, carries a management fee of 40 basis points and utilises professionally managed portfolios.

Managed FidFolios aimed to “open the door to the next generation of customers who don’t have either the asset level or the inclination to work with an adviser yet”, Ram Subramaniam, Fidelity’s head of wealth management and digital advice, told Barron’s.

Fidelity’s services are cheaper than most of the competition and require a lower asset threshold. Charles Schwab, for example, recently launched Schwab Personalized Indexing, which requires a $100,000 account minimum and also has a 40bp fee. Schwab’s service requires less than half the minimum of Vanguard Personalized Indexing and Goldman Sachs’ Tax-Advantaged Strategies, both of which require a $250,000 minimum investment.

Fidelity said its existing direct indexing offering had more than $33bn in assets. They are held within separately managed accounts, which carry “high minimums to invest”, it said.

Solo FidFolios users can start investing with $1 per stock and select up to 50 securities in each portfolio, including fractional shares.

Fidelity’s move is likely to be an “asset-gathering play” as it attempts to become a major player in the low-cost direct indexing space, said Scott Smith, director of advice relationships at Cerulli. Offering customised portfolios that align with investor goals is “the way the industry is going”, he added.

About 58 per cent of retail investors are interested in consolidating all their investable assets into a single institution, according to a recent Cerulli report.

“The FidFolios could certainly be a differentiator nudging Fidelity to the top of some investors’ list of consolidation providers,” Smith said.

Retail investors are missing out on active funds’ outperformance of passives because they pay higher fees than institutional investors, new research shows.

Different fee levels mean fund share classes that are accessible to institutional investors have outperformed passives, but retail investors’ share classes have underperformed, a group of four Dutch researchers has found.

The research paper, Fund Selection: Sense and Sensibility, is the result of analysis of the performance of Luxembourg and Ireland-based Ucits equity and fixed-income funds between 2008 and 2020.

Actively managed funds’ performance, both gross and net of costs, was compared with passive funds and index benchmarks, with results weighted by funds’ assets to reflect where most client money was held.

Active equity funds on average outperformed passive funds by 0.56 per cent a year before the impact of costs was included.

Looking at 35 separate equity fund categories — such as global emerging markets and UK large caps — the researchers found that active funds outperformed in 28 categories, or 80 per cent, although this outperformance was only deemed to be statistically significant for six of them.

This outperformance “weakened” when the impact of funds’ fees was included in the analysis.

Evidence of outperformance was “still there” for 25, or 71 per cent, of the fund categories when looking at institutional share classes after accounting for fund fees.

But this evidence is only present for 16, or 46 per cent, of fund categories when retail share classes are examined.

“Active equity managers can outperform the passive alternative when fees are reasonable,” the authors concluded.

The research is “less supportive” for active fixed-income managers, the researchers said.

“Retail investors experienced negative net outperformance due to the level of fees across fixed-income categories.”

But even for fixed income, lower fees meant institutional investors experienced positive net outperformance in three of the seven fund categories assessed.

The researchers also presented active funds’ outperformance of passives in absolute terms. By combining percentage returns with funds’ total net assets, the researchers found the average “value added” by active funds each year.

Using this approach, active equity funds on average were found to add value of €220,000 a year before fees for retail investors.

“Unfortunately, the retail investor — given the fees — could not benefit much from this active management skill since the average €410,000 in fees charged largely exceed the gross value added,” the researchers write.

As a result, average active equity funds ended up losing value for their retail clients of €190,000 a year.

This finding was not consistent across all fund categories, however, with average active funds in 15 categories, 43 per cent of the total, able to deliver positive value to retail investors after fees.

Retail share classes’ ongoing charges averaged 1.71 per cent, while institutional classes averaged 0.82 per cent across all active equity funds analysed, the research shows.

Equivalent charges for fixed-income funds averaged 1.13 per cent for retail clients and 0.47 per cent for institutions.

Ucits funds’ retail share classes are distributed across widely different geographies, most of which still allow for the payment of retrocessions, which increase the funds’ annual charges, the researchers added.

“As the ban on retrocessions becomes more widespread, we would expect [ . . .] retail fees to decrease to reflect this change,” Jan Jaap Hazenberg, one of the report’s authors, told Ignites Europe.

“They could/should eventually converge to the institutional level,” he said.

*Ignites Europe is a news service published by FT Specialist for professionals working in the asset management industry. It covers everything from new product launches to regulations and industry trends. Trials and subscriptions are available at igniteseurope.com.

An analysis of 6,000 US funds has concluded there is no such thing as a “good” or “bad” investment in terms of the UN’s Sustainable Development Goals.

Instead, the picture is far more complex, according to Util, a sustainable investment data specialist, which is calling for the unbundling of environmental, social and governance (ESG) factors in a report that identifies leaders and laggards according to UN SDGs.

“Almost every company, industry and fund impacts some goals positively, others negatively,” Util said in its report released on Thursday that used machine learning in its assessment.

For example, it found that the 10 laggards on Climate Action were mostly utilities funds. Against other SDGs, however, every one of them is among the top 100 leaders in terms of the Quality Education; Affordable and Clean Energy; Decent Work and Economic Growth; and Industry, Innovation and Infrastructure metrics.

The “E”, “S” and “G” represented such different, even conflicting, objectives that it was time for the concept to be scrapped, the company argued.

“What our research highlights is the need for an approach that allows for a lot of different investor preferences,” said Patrick Wood Uribe, chief executive of Util, adding that attempts to categorise companies as only good or bad did not meet the need for nuance.

“This is more accurate,” Wood Uribe said, adding that it fitted with a global trend towards more personalisation.

For some funds, for example the BAD ETF, a US-listed exchange traded fund that focuses on the betting, alcohol, cannabis and drugs (biotechnology and pharmaceutical) industries, its laggard status according to three UN SDGs is exactly where its founder expected it to end up.

“I wouldn’t want to say that we are totally contra ESG, but we don’t think that investors should sacrifice their returns because of some stigma or something,” said Tommy Mancuso, president and founder of the BAD Investment Company.

BAD, which launched in December last year, has $8.7mn in assets under management and has lost more than 16 per cent since the beginning of the year. Mancuso is adamant, however, that the fund is well positioned to benefit from regulatory changes and a general market upturn.

“I’m in complete disagreement with any person who tries to shame someone for the way they invest. In the end, we invest to make money,” Mancuso said.

In the laggard sections across the board, funds focusing on the extractive industries feature heavily. BAD was identified as a laggard according to the Quality Education, Gender Equality and Decent Work and Economic Growth metrics. It did not score highly on any metric.

Kenneth Lamont, senior fund analyst for passive strategies at Morningstar, said the report’s findings were welcome in many respects, although he cautioned against putting too much faith in the actual rankings, given the unreliability of data from some developing and frontier markets.

“The paper is right to call out some aspects of ESG and sustainable investing. It is a highly complex topic which is often highly subjective, sometimes contradictory and often reduced to unhelpfully simple metrics,” Lamont said.

Util defended its decision to include funds that had not even set out to perform well according to UN SDG metrics.

“While demand is growing for tailored funds hooked around individual social or environmental concepts, we’re also moving away from the idea that ‘brown’ or ‘dirty’ activities should be scrubbed from portfolios,” Util said.

Growing social and environmental pressures are reshaping economies before our very eyes, creating both risks and opportunities for investors.

A forward-looking view of our fast-evolving world, rather than a reliance on past drivers of investment success, will prove critical to profitable portfolio management.

But many investors have turned to passive funds over recent years — an approach that is most unlikely to deliver the best results.

I say this as an active manager. But hear me out.

Passives now account for over one-quarter of global investments in sustainable funds. While this momentum has clearly demonstrated the demand for low-cost, easy access to global markets, investors in passive sustainable funds risk a mismatch between what they expect and the reality of what they receive.



With traditional investment criteria, views of categories such as “large cap” or “high yield” are relatively consistent. So investors in passive strategies focusing on such characteristics have a good idea of the sorts of stocks those funds will hold.



But sustainable investment is very different. There are stark inconsistencies between the scores awarded to companies by different environmental, social and governance (ESG) rating firms, many of which are used to populate the indices of numerous passive ESG products.

This is clear even among the most widely used and well-known scoring systems for company ESG measurement. Passive ESG strategies are therefore only as useful as the ratings on which they are based, which as our research demonstrates, vary considerably. Furthermore, many ratings are backward-looking and so usually fail to predict unexpected controversies.

This is not surprising. For one thing, ESG analysis encompasses a huge range of topics and the importance attached to each can vary significantly. More importantly, sustainability performance cannot be captured by quantitative analysis alone.

All this underpins the importance of an active investment approach.

Identifying a company’s ESG characteristics requires fundamental, bottom-up, forward looking analysis, where views are unavoidably going to differ across firms.



For active managers, this creates opportunity. Active managers by their very nature have a vested interest in the companies in which they invest: sustainable businesses underpin sustainable returns so by helping businesses become more sustainable is likely to benefit their overall portfolio and the returns for clients.

The active managers’ extensive insight and knowledge into companies and industries is critical to meaningful and thoughtful discussions to help drive change, tackle challenges and ensure company management teams are held to account to make the transition.

There is no simple, single answer to achieving a sustainable future. It will require significant time and investment in helping local and global corporates make the change.

So how can we accelerate this?

Rather than using screens to exclude vast swaths of companies, the key approach is to engage and influence as thoughtfully and comprehensively as possible. This ethos has been long established at Schroders and is an inseparable part of our investment process.

Most of our fund managers and analysts now have targets on high-quality engagements. From this year, these are assessed and form part of fund manager appraisals and the results therefore affect their earnings. Over time, we expect the breadth and intensity of our engagements to grow.

But engagement by itself is not enough. Measurement is critical to success. Any fund manager making a decision without first assessing the costs or benefits each company has for the environment and society is, to put it bluntly, flying blind.

The results of our latest Institutional Investor Study at Schroders clearly show that clients are also keen to understand. We must strive to show how different company behaviour on issues such as taxation, healthcare and innovation can deliver social costs or benefits.

We must also offer a granular view on carbon emissions on a company by company basis; and not just focus on the emissions accrued directly or through the firm’s value chain, but also consider the knock-on emissions created and rarely accounted for. There are other factors and nuances to consider in this debate. While it is true that large, passive managers have increased the size of their stewardship teams, a scaling up of thoughtful, critical analysis and diligence is far more difficult to replicate.

Clients will make their own assessments. By asking each portfolio manager for clear examples of effective engagement and a clear view of the sustainability profile of their portfolios they can make a clear-sighted judgment.

Over the long term, the importance of an active approach to sustainable investment will only become increasingly obvious.

Rory Bateman, is co-head of investment and head of equities, at Schroders. The views are his own

Index providers charge some asset managers 13 times as much as other clients for similar bundles of products and services, according to research into the opaque pricing models that could lead to higher costs for investors.

Trillions of dollars are benchmarked to financial indices, but the costs paid for access to them remains a tightly guarded secret. Index providers often bundle products and services, which makes accurate like-for-like comparisons problematic for asset managers to find.

Regulators have stepped up their scrutiny of index providers. The UK’s Financial Conduct Authority is soon to publish the results of an investigation into “unnecessarily complex licensing arrangements” and barriers to switching between benchmarks that could result in price increases for users.

The research by Substantive Research, a consultancy, found that prices for indexing licenses for similar bundles of products and services varied by up to 13 times. The research was based on data from 40 investment managers that oversee combined assets of $5tn.

“Index licensing costs can vary widely depending on the terms of the contract. Index providers also cross-subsidise across their ranges so a user might get a discount if they buy another product or service. But the application of discounts also appears to be inconsistent, which makes it difficult for users to know ‘how well am I doing?’ compared with my peers,” said Mike Carrodus, the chief executive of Substantive Research.

Alan Miller, chief investment officer at the London-based wealth manager SCM Direct, which specialises in building index-tracking portfolios, avoids using popular indices, such as the FTSE 100, as benchmarks.

“We don’t want to get clobbered with license fees for using index brands, such as FTSE, so we look for alternatives to reduce costs for our customers,” said Miller.

Revenues earned worldwide by index providers reached a record $5bn in 2021, up 23 per cent on the previous year, according to the consultancy Burton-Taylor.

But none of the largest index providers — MSCI, S&P Global, FTSE Russell and Bloomberg — provide any detailed public data about the costs of their products and services, which have become essential for the efficient functioning of financial markets globally.

Substantive Research also found significant variations in the costs of market pricing and reference data, for which some institutions pay up to 10 times more than their peers. Reference data include unique identifiers for securities, derivatives, dividends, bond coupons and the multiple counterparties that participate in the millions of transactions that are completed daily across financial markets globally.

“Some data providers are more inconsistent than others in what they charge. The lack of transparency around pricing leaves data procurement teams struggling to manage costs with their budgets consumed by ‘must-have’ benchmarks, ratings and market pricing data,” Carrodus said.

High cost inflation for data services — which are seen as essential for compliance, regulatory and technology purposes across the asset management industry — is another problem cited by users and is in contrast to pricing for investment research, which has fallen sharply in recent years, added Carrodus.

Substantive also found smaller but significant differences in credit ratings data, which are widely used to evaluate debt issuers with some institutions paying three times more than peers. S&P Global, Moody’s and Fitch dominate the credit ratings market.

The UK regulator’s scrutiny of markets data includes credit ratings and benchmarks in a single study that has requested feedback from a range of participants, including asset managers, pension providers and trading platforms.