PowerShares Launches 4 Active ETFs: Only the Beginning?

By Heather Bell

A couple of weeks ago, Bear Stearns (BSC) launched the first actively managed exchange-traded fund, but on Friday Invesco PowerShares became the first ETF provider to launch a family of active ETFs. The four long-awaited PowerShares ETFs are listed on the NYSE Arca exchange.

The four funds really come in three flavors: Two of the funds use a proprietary, quantitative stock-screening methodology developed by AER Advisors, the firm that manages both ETFs. Another is a low-duration fixed-income fund managed by Invesco, while the fourth fund, also managed by Invesco, bears the closest resemblance to what most people would consider a traditional active stock fund, although it too has a highly quantitative element.

The PowerShares Active AlphaQ Fund (PQY) and the PowerShares Active Alpha Multi-Cap Fund (PQZ) both select their holdings from the NASDAQ Stock Exchange. For PQY, AER essentially takes the largest 100 NASDAQ-listed stocks and applies its proprietary methodology to select approximately the 50 most attractive stocks. AER reviews the rankings assigned by its methodology on a weekly basis; it can make three trades a week to replace holdings with the highest-ranked of the stocks that are not already owned by the fund. Other adjustments can be made to keep all 50 holdings approximately equally weighted within the ETF at about 2% - if a company grows to a 3% weighting, for example, its weighting will be reset. According to materials from PowerShares, the fund is invested mainly in growth stocks.

PQZ has almost the same exact rules, except that it draws its components from multiple size and style segments. It has a concentration in large-cap, style-neutral stocks.

The PowerShares Active MegaCap Fund (PMA), the ETF that is most like a traditional active mutual fund, is designed to be a core portfolio holding. It invests exclusively in large-cap, style-neutral stocks. Its universe includes the components of Russell Top 200 and other "mega"-cap stocks that have been screened for liquidity. Like AER, Invesco bases the stock selection on a proprietary methodology. The methodology is based on earnings momentum, price trend, management action and relative value, and stocks are also screened for risk. Unlike the AER-managed funds, PMA can trade as necessary, although PowerShares has said that it anticipates executing trades only on a monthly basis.

All three of the funds charge expense ratios of 0.75%. This is on the high end of the ETF range but less than many index-based ETFs.

Despite all the hoopla about the "first to market" issue, the PowerShares Active Low Duration Fund (PLK) is really the only fund that could even be considered to be remotely competitive with the Bear Stearns Current Yield Fund (YYY) - and even that is a bit of a shaky pairing. PLK targets a duration of 0-3 years, while YYY targets a maximum duration of just 180 days. It seems far more likely that these funds will be in greater competition with existing ETFs that have similar portfolios and possibly with standard mutual funds.

PowerShares has positioned PLK as a tool for dealing with interest rate risk and as a possible core portfolio holding. Its holdings are heavily tilted to high-quality fixed-income securities of durations of 0-3 years, although it does hold some low-quality issues and some with durations of 3-10 years. No more than 25% of its holdings can be in noninvestment-grade securities. It charges an expense ratio of 0.29%.

The future of these ETFs is uncertain. The question is whether investors will pour money into them immediately or hang back to see what kind of performance they produce. While index-based ETFs can often provide a reliable index history, the same cannot be done for actively managed ETFs. Currently, YYY has about $50 million in assets, which is no small amount for a newly launched fund, so there is some clear investor interest in these types of products. If that investor interest is enough to support more actively managed ETFs, the launches taking place now could represent the start of yet another massive growth spurt for the industry just when things were beginning to wind down a bit.

• You can read the prospectus for the new PowerShares funds here.
• More on choosing the right ETF