Why Investors Avoided Actively Managed ETFs in '09

Includes: GVT, PMA
by: Gary Gordon

Recently, I received an inquiry about the state of actively managed ETFs. Had my position on their viability changed since the beginning of the year?

Answer? Nope. The so-called actively managed vehicles are for the most part poorly conceived, low-volume losers.

I’m not alone in my beliefs either. None of the existing actively-managed ETFs have sufficient assets under management. Some have already been killed off due to lack of interest. Others appear on Ron Rowland’s ETF DeathWatch.

In truth, actively managed ETFs provide few of the benefits that have made ETFs the investment vehicle of choice. In fact, while they have been trying to capitalize on a surge in ETF popularity, they have failed to capitalize on the benefits of traditional ETF investing.

What makes ETFs so fantastic? Trade-ability, Tax-efficiency, Transparency and Total Expense. (Note: I had to work hard to get another “T” in there for the low expense of passive indexing.)

In what ways do actively managed ETFs benefit investors? On trade-ability, actively managed ETFs lack sufficient volume. The bid-ask spread for funds like PowerShares Active Mega-Cap Fund (NYSEARCA:PMA) and Grail Large Value (NYSEARCA:GVT) is often as high as 0.5 -0.75%; that can add as much as 1.5% of extra expense in a round-trip trade.

On tax-efficiency, passively tracking an index means very little buying or selling, except when the index is changed. However, Actively Managed ETFs serve up plenty of trading activity; ergo, they’re not tax-efficient.

Okay, so they’re not tax-efficient and they’re not very tradeable. They’re at least transparent, right? Isn’t that supposed to be the big difference between actively managed ETFs and Closed-End Funds?

There may be more transparency than a mutual fund that doesn’t open its books until 3 months after trades have been made. Yet where exactly is the open book on ever-changing, actively managed positions? Do you have to go to the fund managers’ web site each and every day to find out what’s happening?

The point of buying an exchange-traded index investment is so that you don’t have to check it every 5 seconds. The transparency of an index means that you know exactly what that index is and exactly what you’re getting into!

Finally, total expense… where it’s not even close. Forget the hidden cost of bid ask spreads for a moment, and just go the expense ratio. All of the so-called actively managed ETFs cost more than the passively managed alternatives. You’re the one who has to pay for the supposed stock picking prowess. And yet, nothing in performance suggests an ability for risk-adjusted outperformance.

Disclosure Statement: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company and/or its clients may hold positions in the ETFs, mutual funds and/or index funds mentioned above. The company does not receive compensation from any of the fund providers covered in this feature. Moreover, the commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.