Active ETFs: A Race to the Starting Line

By Matthew Hougan

The race to launch the first actively managed ETF is really a race to the starting line.

We've been covering the run-up to the first actively managed ETF launch closely. From an industry perspective, it's an exciting development, and the first fund to list will be historic.

But really, the launch of the first active fund will be just the start of the active ETF saga. Historically, the first ETF to market gets all the glory (and all the assets). That's why ETF providers fight tooth and nail to be first to launch. Just look at the streetTRACKS Gold (GLD) fund vs. the iShares Gold ETF (IAU).

But with the active funds, I'm guessing that the ramp on assets will be longer and that the funds will compete on performance. My feeling is that most investors will want to wait to see how the ETFs perform before they make allocations.

So in the run-up to the first official launch, it's worth keeping expectations in line. Yes, this is a major development in the ETF space with long-term implications. Yes, active ETFs (both fixed-income and equity) have inherent advantages over competing active mutual funds. And yes, "active ETFs" that rely on quantitative strategies may have advantages over index-based ETFs that rely on quantitative strategies, because the one-day lag in reporting will prevent front-running by hedge funds and other traders. (I'm not 100% convinced that this latter impact will be measurable, but it could be ... we'll have to see how the performance shakes out.)

But despite all that, we shouldn't expect the first fund out of the gate to garner $1 billion in assets overnight. Will investors want to access active strategies through ETFs? Will brokers and advisors recommend them? Will the ETFs trade with tight spreads?

I'm excited about the prospects for active ETFs, for sure. But I don't think all the attention will translate into instant assets. The pioneers looking to open up the active market to ETFs should be congratulated, but the launch of the first fund will only be the first step in a long-term process.

• More on choosing the right ETF

Comments

[Reinhard:]

I agree that an actively managed ETF would be a huge development. Although some ETFs that have futures or trade inversely seem to have adopted some complex strategies already. Of great advantage seems to be the tax situation. I heard that if the investor holds the ETF for longer than a year, he has to pay only the long-term capital gains tax rate. This even if the fund uses options, shorts which are normally taxed at short-term rates. Similar with frequent trading of the fund manager, would a long-term investor be shielded from the short-term capital gains taxes? This almost sounds too good to be true, and every active manager would want to open an ETF. I certainly would want to. But am I correctly informed? Or will the IRS close in on this and adapt rules similar to mutual funds in that there will be short-term capital gains distributions required?

2008 Jul 30 08:31 PM