Where Experts See Active ETFs in 2011

by: Shishir Nigam

As industry experts take out their crystal balls at the beginning of a New Year and try to see where the rapidly growing ETF industry is headed, actively-managed ETFs are on the radar screens of many. But the debate regarding the level of success active ETFs will achieve remains just as polarized. One thing that most observers agree upon is that, like it or not, more active ETFs are going to hit the markets in 2011. Here’s what the experts think:

Scott Burns, director of ETF Research at Morningstar, speaking to Jeremy Glaser, believes actively-managed ETFs will add a new atmosphere to what’s happening in the ETF space:

So we do expect to see new entrants in the active space from some of the traditional fund companies, and also more active just from the entrenched ETF providers as we see. So active is definitely going to be a place that’s going to grow. And I think combining with active and maybe even bringing in some of the passive, the other area where we really expect growth in ETFs next year is going to be in alternatives.

Again, a lot of that started this year, but we’re seeing alternative flows, whether in mutual funds or ETFs, really starting to accelerate, and we’re talking more like the hedge-fund-like strategies, where you are … looking at more absolute-return-type strategies and other portfolio, risk-management-type tools. So I think that we’re going to see a convergence of actively managed hedge-fund-like strategies really moving more into the mutual fund space, but the more passive, beta-like, just passive return, like a merger-arbitrage return or a momentum return, showing up as ETF vehicles and passive vehicles in the ETF space.

Chuck Jaffe, writing for The Boston Herald, expects the floodgates to open for actively-managed ETFs, bringing not just sound investment strategies to investors, but also many flashy and gimmicky funds:

Results have been nothing to crow about, but that makes no difference to the people pushing actively managed ETFs. Now that the floodgates have opened, expect a flood.

There are any number of active ETF ideas in registration or on the drawing board, and you can count on many of them to be ridiculous, faddish, gimmicky or just plain dumb.

Amanda B. Kish, writing for The Motley Fool, looks at the big issuers planning active ETF launches and sees a big year ahead for active ETFs. She questions whether they will turn out to be the “mutual fund killer” they are made out to be and ultimately cautions investors from jumping on the new product bandwagon:

So will active ETFs be the mutual fund-killer that many predict? Well, it’s possible that once active ETFs hit a critical mass in the market, they may in fact steal business from more expensive actively managed mutual funds. However, given that mutual funds have a solid toe in the retirement plan world, where the majority of investors’ assets lie, I wouldn’t count on them being dethroned any time soon.

Many new active ETFs will be of the offbeat or narrowly focused variety, rather than a broad-market, diversified option that would be appropriate for most investors. That could lead to a lot of folks buying unnecessary and inappropriate funds just for the novelty factor - a sure recipe for disaster.

The bottom line is that while some investors may find a use for active ETFs, right now most folks shouldn’t spend too much time worrying about them. These funds are still relatively new, and I’m a bit hesitant about jumping onto the new product bandwagon.

Likewise, Benjamin Sheppard, with Investing Daily, sees a place for active ETFs but feels they will confuse ETF investors overwhelmed by choices even more:

It would be foolish to say there’s no place for active management in the world of ETF investing. While it’s possible to build expertise across many industries, there are going to be times when the prudent investor will delegate investment decision-making to a true expert.

We’ve seen an explosion of me-too funds that track the same basic indexes as a host of other ETFs already on the market. While that’s generally a positive trend - greater competition generally exerts downward pressure on expense ratios - it also makes it tougher for investors to divine which fund will help them achieve the exposure they’re looking for. Add active management into the mix - and actively managed funds will inevitably carry higher costs - and investors may find it more difficult to choose an ETF.

Finally, Noah Hamman, CEO of AdvisorShares, spoke to Bloomberg Radio, and was naturally bullish on the prospects for active ETFs. AdvisorShares has been one of the most successful issuers of actively-managed ETFs, launching four new funds in 2010, many of them launching to strong investor interest. Hamman points out that AdvisorShares prices its active ETFs relative to other active vehicles, not passive ETFs. Asked whether active ETFs will mean the death of mutual funds, he disagrees, suggesting that the various types of investment structures will likely co-exist because different types of advisors gravitate toward different instruments.

Disclosure: No positions in above-mentioned names.

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