Active ETF Growth Will Not Parallel Index ETFs

by: Shishir Nigam

Many market observers have suggested that actively-managed ETFs will be the ones to look out for in 2011. Some believe that their growth will accelerate in the coming year as investors recognize their benefits and advantages over actively-managed mutual funds that still hold the vast majority of investor assets. Others see a slower transition into primetime because of continued regulatory and structural hurdles faced by the industry. Whatever the stance might be, Active ETFs are definitely being watched with interest.

Jackie Noblett, interviewed several key participants in the Active ETF space for and found that some of the issuers behind actively-managed ETFs currently on the market feel Active ETF growth will not parallel what the index ETF space has seen over the last decade. Noah Hamman, CEO of AdvisorShares, commented:

I think what we’ll see is not a big explosion, but a healthy amount of new products and nice, healthy amount of asset growth.

The reason for that, according to Hamman, is that investors need to assess the manager and their strategy when it comes to Active ETFs, whereas with index ETFs, they just have to decide whether they want it or not.

In our view, another factor that could slow down the growth of actively-managed ETFs is that they are positioned as substitutes to other investment vehicles – mutual funds – that are already providing the same underlying strategy to investors. Compare this to the arrival of other new ETFs such as commodity ETFs. Before commodity ETFs arrived, retail investors had very few easy ways of obtaining exposure to commodities, unless they were comfortable transacting in futures or owning physical commodities. This is why when commodity ETFs finally showed up on the scene, they saw explosive growth and continue to do so because they provide access to an asset class or strategy that was not as easily available before.

So bringing it back to Active ETFs, while they provide definite structural advantages over mutual funds, they are not providing something very new when it comes to the underlying strategies. There are exceptions such as several hedge-fund type and multi-asset class tactical strategies that have gotten strong traction. But most actively-managed ETFs have relatively plain-vanilla strategies that investors can already easily access currently and this could slow potential growth of the sector.

As the Ignites article mentions, it is also unclear how many issuers will make a strong commitment to the Active ETF space, despite the fact that a large number of them have indicated their interest in entering the arena through SEC filings. Scott Burns, Director of ETF Research at Morningstar, mentioned to Ignites that he feels most of these players are serious about their plans, saying:

A portion that have filed did it as an option, but the vast majority are actually looking at it as a real opportunity.

Some players, like Grail Advisors, have already had trouble as Grail filed with the SEC recently to reveal that there will be a pending acquisition of the company, but if the transaction is unsuccessful, it will have to shut down its five remaining Active ETFs. Bruce Levine, COO at WisdomTree Investments, also spoke to Ignites about this, saying:

I think success in this business is predicated on lots of different things. One is the regulatory ability to move forward, but it’s a lot more than that. It’s creating unique products and it’s having the sales and marketing force to attract interest in those products. Grail seemed to have one piece of the puzzle, but not the rest.

Given that AdvisorShares is the only small provider left in the space, with the acquisition of U.S. One by Russell, this might well point to the importance of size and “staying power” going forward.

Disclosure: No positions

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