Active ETFs: And They're Off!

By Jim Wiandt

We finally REALLY have actively managed ETFs in the market. And many more are to come. Here's why it is a big deal.

The definition of an "actively managed" ETF has always been kind of a squirrelly thing ... but in recent years, conventional wisdom in the ETF business had settled on a popular definition, which has finally been met. By my own account, PowerShares had to do it twice. I have always thought the first two PowerShares ETFs (the ones that bolted out of the gate at just the right time, wildly outperforming the S&P 500 and NASDAQ 100 indexes and underwriting the success story for the rest of the PowerShares family) were "active ETFs."

To me, active is about alpha. And essentially, if you're aiming to outperform an index bogey, that to me is "active" whether or not the stocks are quantitatively or hand-picked. Of course, the industry definition does not agree with mine, and over the years, the anticipation of "active" came to mean "partially or completely hidden real-time portfolio."

And so now that's what we have with PowerShares (the odd YYY fund gets a soft disqualification for essentially being a cash product, and being launched right in the midst of Bear Stearns' demise).

And the floodgates, we understand, are just about to open on actively managed ETFs. Several other players are about to get into the business, and large traditional actively managed mutual fund managers are casting a wary eye at these newfangled exchange-traded funds.

So why is all of this a big deal? Well, because it is my firm opinion that the ETF structure is making active management BETTER. Instead of 150 basis-point products, we're at 75 basis points. Instead of tax-inefficient funds forced to hold the lowest-cost basis stocks and pay out distributions on both portfolio changes and shareholder redemptions, ETFs offer better tax efficiency.

And for those of you who disagree with me owing to the fact that the active ETFs may have less flow and therefore less opportunity to increase the tax basis, I would respond that by and large, it can only put the fund in a better position than the traditional fund (save possibly on the rare occasions when a poor market can actually reward the fund as it tax-loss harvests the lowest basis stocks to offset nominal gains).

But I digress. In short, all other things being equal, you've got a more cost-efficient structure, better transparency and better tax efficiency with the ETF structure, and of course you've got the flexibility to go real time if you need to. So to me, if quality wins (and the evidence of lower fees and better diversification in the wider mutual fund industry indicates it does), this is great news for that overwhelming 80%+ of mutual fund investors who know nothing but active investment.

Look for Vanguard and others to eventually enter the space as well, and further put a dent into the mutual fund industry (and let's remember, as yet, it's still just a TINY $600 billion dent in a $10+ TRILLION industry). But the flows are coming, as are, now, the revenues, as you saw from my recent analysis.

Again, for perspective, a lot of you complained about me pointing out the revenues as if it were a strong criticism of the industry. I would call it just sort of a notice to folks to see what's going on as the industry grows. That data is extremely interesting. But bear in mind that the big active funds make MULTIPLES of the kind of revenues you're seeing in the ETF space.

• More on choosing the right ETF