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iShares, the largest issuer of U.S. ETFs that was acquired last year by BlackRock, has received SEC approval to introduce actively-managed ETFs. iShares currently offers more than 200 passively-indexed ETFs, and the recent SEC decision opens the door for the company to introduce exchange-traded products not linked to a specific benchmark. iShares ETFs had aggregate assets of about $460 billion at the end of February, representing about 43% of the U.S. market.

iShares had previously indicated that any active ETFs launched would be transparent, meaning that the holdings would be disclosed on a daily basis. The frequent disclosure of underlying holdings has been widely cited as a reason for the slow growth of ETFs, as those requirements could potentially lead to “front-running” issues that would erode returns.

In a November 2010 filing, iShares highlighted two potential active ETFs, thought details on specific strategies or holdings were limited:

  • iShares Active Fixed Income Fund: This ETF would seek to deliver a combination of income and capital growth, and the filing notes that investment decisions would be based on “a systematic method that relies on proprietary quantitative models to allocate assets among various bond sectors by evaluating each sector’s relative value and risk-adjusted return.”
  • iShares Active Equity Fund: This active ETF would seek to provide long-term capital appreciation according to the filing, which went on to mention that the fund would invest primarily in large cap stocks. The active equity ETF would draw from the largest 1,000 U.S.-listed stocks, selecting holdings based on relative return potential. “The weighting of the securities will be consistent with research suggesting that equal weighted approaches to stock selection may provide superior risk adjusted returns,” noted the filing - an interesting insight considering that most iShares ETFs are linked to market capitalization-weighted benchmarks.

Mixed Success to Date

The tremendous potential of the active ETF space has been widely touted, but results so far have been mixed. Investors have been slow to embrace active equity ETFs, as these products have been unable to develop meaningful asset bases over the last several years. The four actively-managed PowerShares ETFs that made their debut in 2008 (PQZ, PQY, PMA, PSR) have aggregate assets of about $60 million, while Grail Advisor’s lineup of active equity products - RWG, RPX and GVT - has less than $20 million in total. Earlier this year, Grail indicated in an SEC filing that it had entered into a letter of intent “concerning a transaction involving ownership interests in order to continue its operations,” sparking speculation that the firm behind what many consider to be the first true actively-managed ETF would be acquired by a larger firm looking to gain an active ETF foothold.

While active equity ETFs have been slow to take off, active bond funds have seen impressive inflows. PIMCO offers four active bond ETFs, led by the money market alternative MINT that has accumulated more than $1 billion in AUM since debuting in late 2009. WisdomTree‘s actively-managed Emerging Markets Local Debt Fund (NYSEARCA:ELD) and Asia Local Debt Fund (NYSEARCA:ALD) have been tremendously popular as well. Those products have assets of about $680 million and $150 million, respectively.

Watchful Eye

More than a dozen companies have petitioned the SEC for so called “exemptive relief” to launch active ETFs, including many well known mutual fund managers and financial services companies. Approval of new applications has slowed over the last year as regulatory agencies have engaged in an extended review of the use of derivatives in ETFs and mutual funds, leaving the perimeter of the active ETF arena crowded but only a handful of companies able to introduce products (for details see Handicapping the Active ETF Race).

It’s possible that if iShares pushes ahead with plans for active ETFs, other firms could accelerate their plans to jump into the space. Earlier this year Russell acquired U.S. One, gaining access to the firm’s exemptive relief in the process. In addition to Grail, a handful of other companies could be potential acquisition targets for any would-be issuer looking to sidestep the traditional approval process.

Disclosure: No positions at time of writing.

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Source: iShares Receives Approval for Active ETFs