Active ETFs are, well, less active

Dynamics of trading translate into little active management

Apr 21, 2008 @ 12:01 am

By David Hoffman

If investors were expecting the first actively managed exchange traded funds to look anything like their mutual fund counterparts, they are probably disappointed by three ETFs that Invesco PowerShares Capital Management LLC introduced this month. The ETFs strictly limit how much active management is allowed, and their structure doesn't allow fund managers to make too many transactions without tipping their hand to traders looking to jump in front of trades to make a fast buck, industry experts said. "It's not the answer to actively managed ETFs," Gary Gastineau, managing director of ETF Consultants LLC in Summit, N.J., said of Invesco PowerShares' solution. For example, the PowerShares Active AlphaQ Fund and the PowerShares Active Alpha Multi-Cap Fund each limit trading to the last business day of each week. The PowerShares Active Mega Cap Fund doesn't operate with such a restriction but intends to make trades on a monthly basis, according to its prospectus. Only the PowerShares Active Low Duration Fund appears to come without restrictions. That is because it is a fixed-income fund — which seeks to outperform its benchmark, the Lehman Brothers 1-3 Year U.S. Treasury Index, by investing in a portfolio of U.S. government, corporate and agency debt securities — and arbitrage is less of a problem in fixed-income markets than in equities because traders earn little by jumping in front of bond trades. The actively managed ETFs represent just "the first steps" for Invesco Powershares, Bruce Bond, the president and chief executive of the Wheaton, Ill.-based company, said in defending the new products.

Other actively managed equity ETFs will come, possibly without trading restrictions, he said.

Mr. Bond explained that the provisions in the Invesco PowerShares actively managed ETF structure that limit trades to the last business day of the week, or to one time a month, are fund-specific; they aren't embedded in the ETF structure that allows for active management.

What allows for active management is the fact that each ETF's holdings are disclosed daily on a website.

The result, Mr. Bond said, is that there will always be a brief window in which investors won't know what the ETF holds and when managers can make changes to the portfolios without having to worry about arbitrage.

The problem, however, is that the time window is very brief, said Mr. Gastineau, who also is working on actively managed ETFs. He said the time period will be too short for a portfolio to trade large quantities of stock efficiently without incurring higher trading costs.

Portfolios of all sizes will have trouble accomplishing such trades, said Sonya Morris, editor of the Morningstar ETFInvestor newsletter, which is published by Morningstar Inc. of Chicago.

"Based on the fund managers we've talked to that manage funds of any size, it's fairly rare for them to build a position in a single day," she said.

That's the current thinking, Mr. Bond said. But as ETFs continue to catch on, portfolio managers will realize that they can tailor the way they manage money to the structure Invesco PowerShares has developed, he said.

Managers may have to work more closely with their trading desks, but they will be able to execute trades efficiently, Mr. Bond said.

"I think that many managers will get comfortable with it," he said about the Invesco PowerShares actively managed ETF structure.

But even if they do, it's unclear just who the audience for actively managed ETFs is, said Jeff Tjornehoj, a Denver-based senior research analyst with Lipper Inc. of New York.

Financial advisers who use ETFs like to know what's in the fund, he said. Those advisers "may not like the idea of being in the dark" about what an ETF holds, Mr. Tjornehoj added.

PowerShares, however, is looking to broaden the appeal of ETFs not just to those who prefer passive investments but to the large majority of retail investors who prefer active management, Mr. Bond said.

"There are a tremendous number of investors interested in active management that are not investing in ETFs," he said. "They might be very interested in actively managed ETFs."

E-mail David Hoffman at dhoffman@investmentnews.com.

0
Comments

What do you think?

View comments

Recommended for you

Upcoming Event

Oct 23

Conference

Women Adviser Summit - San Francisco

The InvestmentNews Women Adviser Summit, a one-day workshop now held in four cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Featured video

Events

Financial advisers highlight solutions to increase diversity and inclusion

These Excellence in Diversity & Inclusion award winners suggest short-term changes to help foster D&I in the financial advice profession.

Latest news & opinion

Small-cap funds take a beating

For most of the year, the sector had outperformed, but that all changed last week.

SEC commissioner Stein suggests Congress address differing broker, adviser standards

She said lawmakers may have to change 'solely incidental' language that lets brokers give advice.

Social Security and the fear of missing out

How to lower expectations when clients think they're owed a bigger Social Security benefit.

7 things advisers should do today to boost diversity and inclusion

Creating diversity and inclusion within financial advice firms is challenging, but these InvestmentNews Excellence in Diversity & Inclusion award winners have suggestions that firms can put into practice today

The midterm elections: What's at stake for financial advisers

A shift in control of the House could change the course of important issues, including the SEC advice rule, tax reform and retirement policies.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print