Three Reasons Why Active Bond ETFs Are Beating Out Active Equity ETFs

Feb. 9.10 | About: PIMCO Enhanced (MINT)

In the US, there are now 17 actively-managed ETFs trading on the markets. While they were a step forward in the development of the $1 trillion ETF market, no one expected to Active ETFs to take the investment industry by storm. And in that, they have lived up to expectations. Most ETFs that were launched in 2008 and 2009, starting with PowerShares’ five launches, are still suffering from a lack of investor interest, cash in-flows and hence liquidity. However, those Active ETFs brought to market after Nov 2009, have generated more investor interest.

As it turns out, the last 5 Active ETFs to come to market have all been fixed-income ETFs, with two from Grail Advisors and three from PIMCO. Amongst them, PIMCO’s Enhanced Short Maturity ETF (NYSEARCA:MINT) stands tall with a market cap that has already crossed $115 million in a matter of 2 months. This of course has very much to do with PIMCO’s reputation in the fixed-income space and also the fact that it competes directly with the huge market money market funds, which hold 26% of all mutual funds assets in the US.

Active Bond ETFs do seem to be creating a lot more buzz than the Active Equity ETFs and here’s why:

1. Effectiveness of active management

Many empirical studies have shown that active-management, when it comes to equities, may not be very effective in the long-run as, on average, active managers have not been able to outperform their benchmarks. However, the debate over active management in the fixed-income space is still very much alive with many people believing that active managers do add value when it comes to bonds. This is attributed to the much larger size of the bond market, which allows more inefficiencies to persist that active managers can exploit. As such, actively-managed bond ETFs are likely to generate more confidence in their ability to outperform indices than actively-managed equity ETFs.

2. Traditional equity ETF issuers are not active managers

Another road block for traditional ETF issuers trying to get into the Active Equity ETF market has been that these issuers have not previously been involved in active management. For example, when PowerShares launched their first 5 products, 2 of them were sub-advised by another active manager – AER Advisors. Likewise, all of Grail Advisor’s offerings have been in conjunction with 3 different sub-advisors – RiverPark, American Beacon and McDonnell. This is likely the case as well for those issuers, such as Vanguard and Claymore, who have lined up to launch new active products. These advisory relationships themselves take time to establish and whether the reputation and track record of the sub-advisor appeals to investors is another wild-card. Unless, you’re talking of a manager like PIMCO of course.

3. Timing of launches

Finally, the large majority of Active Equity ETFs were launched in 2008 and mid-late 2009. This was a time when the markets were unpredictable and volatile. Even when the market was going straight up, investors feared another major correction around the corner. In 2008, the IFIC reported $12.2 billion in net outflows from equity mutual funds and another $6 billion in 2009. Just as new IPOs don’t do very well in panicky, volatile markets, neither have these Active Equity ETFs. With so much money flowing out of equities, new Active Equity ETFs products were not likely to be well received. With the market now more stable, the new active bond products launched in the last few months have been better received.

With PIMCO planning two more active bond ETFs, it’ll be a good time to test these theories to see if these new issues continue to be as well-received.

Disclosure: No positions