Grail Advisors made a filing with the SEC on Jan 5th, 2011 which indicated that it may be in the process of getting acquired but if the transaction is unsuccessful, the company may have to liquidate of its actively-managed ETFs.
The filing is a supplement that mentions that Grail Advisors has “entered into a letter of intent concerning a transaction involving its ownership interests in order to enable it to continue its operations”. Grail Advisors’ current financial obligations include its contractual agreements to provide fee waivers and expense reimbursements on three of its remaining Active ETFs.
Grail had launched seven actively-managed ETFs in total, two of which it had to shut down in August due to a lack of traction amongst investors. Like the two funds that were shut down, Grail’s remaining five Active ETFs have not done any better, with a combined asset base of just $20 million. Even then only one of those five funds, the Grail RP Focused Large Cap Growth (RWG), has more than $5 million in assets. It’s generally believed that an ETF does not become profitable for the issuer until its asset base is between $50-$70 million. When these funds were first launched, Grail Advisors had contractually agreed to provide fee waivers on each fund to put a cap on the net expense ratio that investors would have to pay, in effect subsidizing some of the costs to attract initial investors. Today, only three of the Active ETFs continue to have fee waivers in place.
The filing indicates that if Grail Advisors does get bought out, shareholder approval will be required in order for Grail to continue being the investment advisor to the ETFs. The acquisition, depending on the buyer’s intentions, may result in liquidation of the ETFs that Grail operates. But if the transaction is unsuccessful and Grail is not able to re-capitalize itself then all the actively-managed ETFs would still have to be liquidated. Liquidation can be approved by the Board of Trustees without shareholder approval.
This development is quite certainly a negative for the Active ETF space. While attrition is inevitable in the ETF landscape, what might hurt more is the loss of the potential new funds Grail Advisors had in its pipeline. Grail Advisors had previously filed for approval to launch an active international equity ETF with American Beacon, an ultra short duration bond ETF with Western Asset Management and most significantly and emerging market fixed income ETF with DoubleLine Capital – the firm started up by famed bond manager, Jeffery Gundlach. Of course, the potential buyer of Grail Advisors might well choose to continue with the launch of these funds, but that’s not a given. The worst scenario for Grail would be if the deal does not materialize, because Grail is likely to find the going very tough if it has to operate on its own – especially since it is probably losing money on each of its actively-managed ETFs at the moment. If the funds do end up being liquidated, investors who trusted in these funds will rightfully feel hard done by. One consolation is that three out of the five remaining Active ETFs likely have very few investors in them as they are still hovering around the seed capital levels they were launched with.
Disclosure: No positions in above-mentioned names.
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