Actively managed exchange traded funds are finally starting to trickle into the market.
But for the trickle to become a flood, active ETFs will have to overcome a number of obstacles, not the least of which is the establishment of desirable performance.
“Would people want active management that comes with the tax advantages, transparency and liquidity of an ETF?” asked Scott Burns, the director of ETF analysis at Morningstar Inc. of Chicago and editor of Morningstar ETFInvestor, a monthly newsletter. “The answer is yes, but if it turns into a tradeoff for returns, the answer is no.”
It is a challenge, but some asset managers think that they are up to it.
The Grail American Beacon Large Cap Value ETF (GVT) from Grail Advisors LLC of San Francisco, which began trading on May 4, allows portfolio managers unrestricted trading.
The ETF is subadvised by Fort Worth, Texas-based American Beacon Advisors Inc., a manager of managers.
Assets in the new Grail ETF will be allocated among three investment managers: Brandywine Global Investment Management LLC of Philadelphia; Hotchkis and Wiley Capital Management LLC of Los Angeles; and Metropolitan West Capital Management LLC of Newport Beach, Calif.
The Grail ETF follows the introduction Nov. 20 of the PowerShares Active U.S. Real Estate Fund (PSR) from Invesco PowerShares Capital Management LLC of Wheaton, Ill., and the launch in April 2008 of the first actively managed equity ETFs, also from Invesco PowerShares.
Invesco PowerShares manages five actively managed ETFs.
Invesco PowerShares, Grail and other asset managers have plans on the drawing board to launch more actively managed ETFs.
Financial advisers said that they welcome such ETFs, but predict it will take time for them to catch on.
“When it comes to actively managed ETFs, you really have to be patient,” said Jim Lowell, partner and chief investment strategist of Adviser Investment Management Inc. of Newton, Mass., which manages $1.2 billion.
Like conventional mutual funds, investors need to let active ETFs build a track record, he said. It may take as long as three years or as little as six months if the manager is already well-known, Mr. Lowell said.
Performance, however, is just part of the equation.
An actively managed ETF has to offer something new, said Adam Bold, chief executive of The Mutual Fund Store, an Overland, Kan.-based RIA with about $3.5 billion of client assets.
“I would buy actively managed ETFs for my clients if they offered something I couldn't find in regular, open end mutual funds,” he said.
There has to be something “unique” beyond the structure of the ETF itself, Mr. Bold said.
That has proven to be something of a stumbling block for early actively managed ETFs as a result of issues stemming from transparency.
The Securities and Exchange Commission insists that ETFs provide investors with transparency equivalent to that of stocks.
Although that isn't an issue for ETFs that follow an index, active managers are leery of telegraphing their moves out of fear that arbitrageurs will jump in front of their trades and wreak havoc on stocks in which they are interested.
So far, the solution has been to limit actively managed ETFs to very liquid fixed-income and liquid large-cap equity markets.
It is a solution that hasn't played well with investors.
Despite solid performance, the three actively managed equity ETFs from Invesco PowerShares have just $15 million in assets, according to Morningstar.
“There are limits — real tactical, structural limits — to how many active styles can be done in an ETF,” Mr. Burns said. “It's hard to do a small-cap actively managed ETF, and virtually impossible to do a micro-cap ETF.”
That may be true, but it won't stop asset managers from coming out with actively managed ETFs, said Sean O'Hara, president of Paoli, Pa.-based RevenueShares Investor Services LLC.
Although not a fan of active management, Mr. O'Hara, whose firm launched its first ETFs last year, said there is so much “upside” to the ETF business — it is growing faster than the mutual fund business — that it is bound to attract asset managers looking to launch new products.
E-mail David Hoffman at [email protected].
