Bear Stearns: All Systems Go for Launch of First Active ETF

By Murray Coleman

The battle of press releases heated up Monday as Bear Stearns (BSC) made public plans to launch what would be the first active exchange-traded fund.

"This is the first actual actively managed ETF to hit the marketplace," said Margo Cook, global head of Bear Stearns Asset Management's institutional business, during a morning interview.

But there's a hitch. The Bear Stearns Current Yield Fund (YYY) won't actually start trading until March 18. In the ETF universe, eight days can be an eternity.

Still, in the fast-moving world of ETF launches where announcements are often made without any specific dates, the Bear Stearns move signaled a hopeful sign that years of anticipation could actually be moving closer to fruition.

A vast majority of mutual fund assets are in actively managed portfolios. Up until now, ETFs have been tied to indexes. Although those benchmarks have been getting more flexible in recent years, they're still a long way from running independently like most mutual funds.

Even though ETFs have outpaced active open-end mutual funds' growth for nine straight years, they started from a much smaller base. Many industry observers believe that the launch of true active ETFs will open the market up even more to a wider audience of investors. (See related story: Index Funds & ETFs Keep Gaining Market Share vs. Active Managers.)

In short, some are likening the birth of active ETFs to the dawning of a new era in the $568.7 billion industry. They see a time when ETFs, both indexed and active, will compete directly for mainstream investors throughout most of the $11.7 trillion mutual fund marketplace.

It's little surprise then to find plenty of challengers lining up to seize the crown as the first active ETF. Among them are four PowerShares ETFs.

Last week, PowerShares issued a press release declaring that group had cleared all regulatory hurdles and was ready to become the first out of the gate. But unlike Bear Stearns, it listed no firm launch date.

Even without such details, statements making it sound like PowerShares had won the active ETF derby by the company were picked up by news organizations ranging from Reuters to the Los Angeles Times. The stories caused a stir among the rest of the field.

Also believed to be nearing the launch stage with active ETFs are WisdomTree Investments (WSDT.PK) and Barclays Global Investors. Others in various stages include Vanguard Group, Grail Advisors and XShares Advisors.

The smart money, however, has always been focused on Bear Stearns as being closest among ETF rivals already approved by the Securities and Exchange Commission for exemptive relief to issue active funds. (See related story: For Truth In ETF Advertising, PowerShares Fails.)

Cook says the firm decided to announce the fund Monday "because we have the authority to announce to the public. We've gotten all of the approvals necessary."

The portfolio has actually started beta, or test trading, according to sources. That presumably put it into a position of actually announcing a launch date.

But it's important to note that no matter who is first, Bear Stearns and PowerShares are competing in different areas. For one, the PowerShares' active fixed-income fund is supposed to have a duration of zero to three years. It's to be called the PowerShares Active Low-Duration Portfolio.

The most YYY's weighted average maturity will be is one year. But Cook says the ETF's average should be closer to 180 days. "So it's just beyond a money market fund but just below a short-duration bond fund," she said.

YYY will also be different in that it won't follow any specific index. "This ETF is not index-based and it's not rules-based," Cook said. "It is truly actively managed."

The ETF will publish its portfolio at the end of each business day. "What's important about this is with the difficulties with money market funds and enhanced cash funds, it's going to provide investors with daily transparency. In mutual funds, you can only see holdings at the end of the quarter," Cook said.

A typical retail money market fund or enhanced cash fund's expense ratio is around 0.65% per year, she added. YYY is expected to charge an expense ratio of 0.35%.

Until it actually begins trading, PowerShares still lurks in the background as the most likely to offer a truly active ETF.

The PowerShares funds include three stock funds and one fixed-income fund. Invesco Institutional and AER Advisors will each subadvise two of the four funds.

Invesco will manage the PowerShares Active Low Duration Fund, which will invest in U.S. government and corporate debt with short-term durations; its performance benchmark is the Lehman Brothers 1-3 Year U.S. Treasury Index.

But in some respects, the proposed active PowerShares ETFs will introduce some unique innovations into the marketplace-whether they're first by a whisker or not.

For one, they'd be the first active stock ETFs. That's significant since more than 90% of all ETF assets are invested in stock-focused portfolios. That's roughly the same percentage of all open-end stock mutual fund assets invested in actively managed portfolios rather than indexed ones.

But perhaps most innovative is that the PowerShares stock ETFs about to hit the market won't follow indexes. That's similar to Bear Stearns' plans for its active bond ETF, but a departure from the rest of the current stock ETF field.

If nothing else, moving to allow Bear Stearns and PowerShares to come to market signals a key shift by the SEC, which in the past hasn't allowed any potential ETFs to launch without being matched to a specific index.

Other differences of note are surfacing. While the Bear Stearns active bond ETF says it'll report holdings daily, the active PowerShares stock funds won't necessarily have the same latitude.

PowerShares will disclose the contents of the portfolios on their Web site each morning. Most days, the fund manager will not be able to make changes to that portfolio. But on the last business day of each week, the fund manager will be allowed to make up to three trades.

Those trades won't show up in public until the following Monday. PowerShares seems to be taking the tack that since such discrepancies will only take place once a week in a limited number of trades, the fund values shouldn't deviate widely from the published holdings.

Other unique features of the PowerShares active stock portfolios include how they'll handle creations and redemptions. Since they can't reflect the fund holdings exactly, creations and redemptions will be made with a basket of securities that will be similar to-but not identical to-the actual portfolio.

In addition, there will be a small cash component to true-up the value of the creation/redemption basket with the value of the portfolio holdings.

But the broadest active stock mandate will likely go to the PowerShares Active Mega-Cap Portfolio, which will be subadvised by Invesco, parent of PowerShares and the AIM family of funds.

Instead of following a fixed quantitative screen, the prospectus gives the Active Mega-Cap manager wider discretion to implement a portfolio. The fund will be able to trade at any time and on any day, in contrast to the once-per-week trading of the other PowerShares funds.

It can also theoretically trade as much as it wants. Changes in the portfolio will be reflected in the fund's published holdings on the following day, meaning the disclosed holdings may always be one day stale. In comparison, existing ETFs reveal their holdings daily.

This fund will follow the same creation/redemption mechanisms as the funds covered earlier, with representative baskets and a true-up cash component.

• More on choosing the right ETF

Comments

[Lisa:]

This is great news. Given the consistent under-performance of mutual funds, actively managed ETFs will be great instruments for shorting. But only if there's enough liquidity.

2008 Mar 10 07:36 PM

[Indexor:]

Murray, you'd feel comfortable putting a client's (safe) short-term money with Bear Stearns??? You might as well give it to Idiot, er...Eliot Spitzer. Have a look at the iShares Short-Term Treasury Bond (SHV) at 0.15 basis points vs. Bear Stearns' 0.35.

2008 Mar 11 06:46 PM