Grail Active ETF Launched, But Is the Market Ready?

Ready or not - here they come. On Monday (5/4/09), Grail Advisors launched the Grail American Beacon Large Cap Value ETF (GVT). Billed as the first “qualitative” actively managed ETF, it joins a lineup of “quantitative” actively managed ETFs from PowerShares. The Grail website has no information about today’s launch other than the April 2, 2009 press release, which also mentions a second fund called Grail American Beacon International Equity ETF.

The new ETF is subadvised by Fort Worth, Texas-based American Beacon Advisors Inc., a manager of managers. Assets in GVT will be allocated among three investment managers: Brandywine Global Investment Management, Hotchkis and Wiley Capital Management, and Metropolitan West Capital Management.

The unanswered question looms large: Is the Market Ready for Actively Managed ETFs?

There are only a handful of actively managed ETFs today, and they have attracted very little in assets. Most of the active ETFs introduced by PowerShares a year ago are now on ETF Deathwatch.

Someday, actively managed ETFs have the potential to become a significant portion of the ETF marketplace. However, the market appears to not be ready for them at this time.

There are three types of investors using ETFs today:

1. The classical/traditional index investor that use index funds in strategic asset allocation strategies. They are migrating to ETFs because they can accomplish the same thing with lower costs and lower tax consequences. These types of investors don’t believe in active management and will never purchase an actively managed ETF.
2. Active managers that include ETFs along with stocks in their portfolios (this applies to both institutional and retail investors). These types of investors/managers believe that “they” are responsible for adding the “active” ingredients to the management of the portfolio. Therefore, they want to use indexed (aka passive) ETFs to provide the exposure they desire. For example, if they want to overweight the energy sector or small cap value, then they want an ETF that is going to deliver that. Since they cannot predict what sectors or styles an actively managed ETF will be investing in next month or the month after that, actively managed ETFs will not be used by these investors.
3. Day traders and hedge funds use ETFs in much the same way as group 2 above, except they trade much more frequently, require very high liquidity (both in high volume and very narrow bid/ask spreads), and require high transparency as to what the ETF owns so that they can be properly used in their trading models. These investors will not have any use/need for actively managed ETFs until they crack the top 20 ETFs in terms of volume, liquidity, and transparency.

Most investors that like actively managed mutual funds will not buy them until they have a three-year or five-year track record that they can analyze and understand how it would fit into their overall portfolio. Investors are not likely to buy an ETF version until the manager can prove that the ETF version behaves and performs the same as the mutual fund version over a multi-year period.

I applaud Grail for blazing this trail and giving us a glimpse into the future, but I don’t think the market is prepared to accept this product at this time.

Disclosure: no positions

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Comments

[Drew Arnold:]

This seems like it would take quite some time to catch on. If you're a talented fund manager, wouldn't you rather manage a mutual fund that charges more for its services instead of an ETF that charges much less? And if you're an investor, wouldn't you rather have your money with a more talented fund manager? It seems like fund managers would rather work elsewhere and investors would rather put their money elsewhere.

May 05 11:09 AM

[Ed Hynes:]

Try the Grailadvisors.com website. It's filled with information about the offering including the current portfolio.

I don't know if these will work, but it's a pretty interesting structure. Effectively all three active funds have an "ETF Class" look alike. One problem though is the managers will trade in the mutual fund before the ETF fund in order to avoid others front running their fund. This obviously means the ETF will always get a worse price and that worries me, especially since most funds already underperform their benchmarks.

In terms of history, at least investors can see how the three funds operate and their returns, which is better than with most of the quant "active" ETFs.

May 05 11:17 AM

[Marvin Lemus:]

Guys check this out bit.ly/168ijw see where they are calling the bottom at on any stock or ETF.

May 05 03:12 PM

[Lee Eugene ...:]

Ron,
I am with you on this one. Not only is the public not ready for an active ETF, but why should they be????
Not only will the trading kill it, but if you want an active manager, you need to give them some room and not trade in and out every day. Active management is best served by way of an open end mutual fund that prices each day. At least then the manager can get his cash balances in order each day.
Lee

May 05 03:52 PM