The Active ETF space first woke up in 2008, found some of its footing in 2009 and really started gaining some attention in the first half of 2010. We’ve seen lots of activity in this nascent sector that is still only a tiny fraction (at $2.11 billion) of the US ETF industry, which stood at $777 billion at the end of June, 2010. But it most certainly has attracted more than its fair share of debate from both the supporters, who think Active ETFs will be a big part of the ETF industry’s push into a mutual fund dominated investment landscape, and those that see Active ETFs as a passing fad that detract from the ETF structure’s “passive roots.”
Only time and, frankly, money will tell which side of the debate takes the honors, but my guess is we won’t be reaching a conclusion in this debate anytime soon. Looking at the bigger scheme of things though, any innovation that does not lead to a polarized debate from existing players, is likely not innovative enough to create any significant change in the industry. Whether it’s on their daily disclosure requirement or on their tax efficiency, the degree of polarization around the debate on actively-managed ETFs quite certainly meets that criterion.
The major players in the industry though are not taking any chances. As of now, each of the four largest ETF providers in the US, a group that cumulatively holds close to 89% of all US ETF assets, has filings with the SEC that will allow them to launch actively-managed ETFs in the future, if they haven’t already done so. Half way through 2010, it is a good time to evaluate how this hotly debated space might evolve and what developments we can expect to see in the 2nd half of 2010.
1. Increase in mutual fund conversion plans
One of the more polarizing debates within the Active ETF landscape has revolved around the prospect of converting existing active mutual funds into actively-managed ETFs. What is the value proposition that such a conversion brings to investors? How would it affect existing shareholders? And to what extent does such a conversion with the Active ETF issuer a head start in terms of having an established track record?
Grail Advisors first discussed this proposition back in March, when CEO Bill Thomas announced that Grail was in talks with several existing mutual fund companies to convert existing funds into actively-managed ETFs. However, that debate really regained steam when recently Huntington Asset Advisors announced concrete plans to roll an existing mutual fund with a 9-year track record into a newly formed Active ETF. While the benefits to shareholders of such a conversion have been debated extensively, the benefits to the Active ETF issuer are quite clear. One of the biggest drawbacks of launching an Active ETF is the long wait until it develops a strong track record. With a mutual fund conversion, the mutual fund’s track record and also the fund ratings carry over to the ETF, provided both structures are being managed to the same strategy and by the same manager. This can be a huge advantage when it comes to active management because a 9-year track record versus 1-year record can make all the difference in attracting investor assets. As such, now that Huntington has gotten the ball rolling, other firms such as those being pursued by Grail Advisors are likely to announce their conversion plans to leap-frog their way into the Active ETF space.
2. Increase in actual product launches hitting the market
There hasn’t been a lack of interest in actively-managed ETFs if you consider the number of SEC filings that we have seen from mutual funds, existing ETF providers and even big name banks requesting exemptive relief to launch Active ETFs. However, in the first half of 2010, there has been a definite gap between how many filings were being made and how many actual actively-managed ETFs were launched on the market. In 2010, only four new actively-managed ETFs actually started trading and opened to investors. This figure compares to 12 in 2008 and another 10 in 2009. In fact, since the end of January 2010 when we saw 3 fixed-income products being launched by Grail Advisors and PIMCO, there has only been one Active ETF launch in the five months since.
Part of this delay in getting products to market can probably be explained by the SEC’s derivatives review that it commenced in March to evaluate the use of derivative products in ETF portfolios. While the SEC’s investigation is focused more on leveraged and inverse ETFs utilizing derivatives as a primary means to implement their strategy, actively-managed ETFs have also come under the scanner. This has likely put the approval plans on hold for numerous Active ETFs filed with the SEC. However, in the 2nd half of 2010, we should likely see more of these products that were put on ice, actually hit the market once the SEC has addressed concerns in a satisfactory fashion.
3. Increase in star manager presence
One of the big things that was seen holding back actively-managed ETFs in the first half of 2010 was the lack of prominent portfolio managers entering the arena and putting their name behind products in order to help attract assets. In April, when we spoke with Don Suskind, Head of ETF Product Management for PIMCO, he expressed reservations that we might be seeing a Total Return Active ETF any time soon from Bill Gross.
In June though, Grail Advisors announced a partnership with DoubleLine Capital to launch a new actively-managed ETF. DoubleLine was started by the renowned fixed-income manager, Jeffery Gundlach, who had a storied departure from TCW but is spoken of in the same class as Bill Gross. At the moment, DoubleLine has only announced plans for one Active ETF, but once they see some level of success in their first launch, you can be rest assured that Grail Advisors will be knocking on their door again to launch more new products. Having now seen the support and confidence from Jeffery Gundlach’s firm, the Active ETF space could well witness more star managers step into the arena in the coming half of 2010. More such entrances will have a definite positive effect on the development of actively-managed ETFs.
4. Increase in specific product filings
Another interesting development has been that many of the new issuers that have filed for exemptive relief with the SEC have not yet disclosed any specific details on the actual product or strategy that they plan to launch. Of the roughly 22 different companies that currently have filings for Active ETFs with the SEC, quite a large number of them represent “placeholder” filings where the exemptive relief would allow the company to launch “future funds” with literally any investment strategy under the sun.
This is likely because many firms want to make sure that they have the relief necessary to launch such products if and when they decide to do so. In effect, what this does is it kicks-off the exemptive relief process with the SEC so that the issuers don’t get left behind in the dust if the Active ETF space really takes off, while allowing them enough room to watch the evolution of the space and decide what kind of a strategy they want to bring to market. As these mutual fund companies and ETF issuers get a better grasp of what strategies are in demand within actively-managed ETFs, we will likely see more specific product filings and preliminary prospectus being filed.
Disclosure: No positions in above-mentioned names.
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