Shishir Nigam's  Instablog

The sole provider of Active ETFs in the Canadian market, Horizons AlphaPro, is set to expand its range of active products even further. Horizons AlphaPro announced on Feb 10, 2010 that they’ll be launching 3 new additions to their active portfolio with the addition of the AlphaPro Dividend ETF (HAL), the AlphaPro North American Value ETF (HAV) and the AlphaPro North American Growth ETF (HAW), all of which will be listed on the Toronto Stock Exchange.

Horizon AlphaPro’s existing line of Active ETFs consists of 5 products which include two actively-managed bond ETFs, one equity ETF and two multi-asset ETFs that invest across equities, bonds, commodities and currencies. One of the multi-asset ETFs includes the AlphaPro Gartman ETF, managed by the highly prominent Dennis Gartmen. The 3 new equity products will definitely appeal to investors looking for active management in equity markets but also the benefits of investing in ETFs.

1. The AlphaPro Dividend ETF will invest in high yielding North American equities and will be managed by Leon Frazer, CEO of Leon Frazer & Associates who are the sub-advisors to the fund. The will be aiming for regular income and modest capital appreciation.

2. The second North American Value ETF will also invest in North American equities and will look to achieve long-term capital appreciation and income. This will be managed by Vito Maida of Patient Capital Management, the sub-advisor, and will utilize a value investment style.

3. The third North American Growth ETF also invests in the same universe but aims for long-term capital growth and is managed by Stephen Rogers, VP at JovInvestment Management Inc. who is the investment manager.

Each of the 3 ETFs will be charging a 0.70% management fee, along with a 20% haircut of the amount by which the funds outperform the S&P500 Index.

All 3 managers have very strong track records with their respective firms and will use their reputation to help these new offerings gain traction. Horizons AlphaPro managed $123 million in assets as of Jan 31, 2010 and these new additions will no doubt add to the growth of the firm as well as the Active ETF space in the Canada. In the words of Ken McCord, President of AlphaPro – “We’re taking their unique investment styles and wrapping them up in an ETF structure that allows investors to get exposure to active management with low management fees.”

Disclosure: No positions in above-mentioned names.

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How does one identify the coming of a trend? You witness the first movers who more often than not have to battle challenges and criticism and may crumble, but if their idea had merit, other people will try it and they will learn from the first mover’s mistakes, figuring out new ways to “package” the idea. And very soon, people will be lining up to take a piece of the new pie and scrambling to get to market with their own versions. That’s when you know the trend has arrived.

The first innovators who dip their toe into the market, usually get it bitten off. The proverbial toe got bitten off alright – Bear Stearns filed for the first “active” ETF in Mar 2007 called Bear Stearns Current Yield Fund (YYY). It came to market in Mar 2008, a day after Bear Stearns’ stock had fallen 50%, and got taken off the shelf in Oct 2008. YYY was a short maturity fixed-income ETF that used active strategies to deliver alpha over average money-market funds. A great idea, but the sheer timing of its launch doomed it to failure as JP Morgan’s $2/share takeover offer for Bear Stearns took over the headlines and association with Bear Stearns created stigma.

However, the potential was recognized by market players and PowerShares was next to market with an active ETF of its own though the managers of those funds did not have much discretion. Even with a short 3-month history, active ETFs were handily beating the passive indexing rivals. Market participants were starting to see the glitter of the active ETF space.

Today, there are 15 active ETFs on the market from providers that include Invesco PowerShares, Grail Advisors, HS Dent Investment Management, Pimco and BlackRock iShares. These 15 ETFs alone have a couple of bond ETFs, many equity ETFs and even one holding futures contracts. The new “packaging” is definitely being experimented with.

And the line of companies at the SEC’s door with active ETF filings is only growing longer. T. Rowe Price, John C. Hancock Funds, FFCM LLC, US Commodity Funds, Putnam Investments, Vanguard and Claymore are all eyeing the space and many have filed for a potential new launch. Even more new variations like commodity ETFs are being talked about.

Active ETFs have arrived and it’s increasingly becoming a question of “when” and not “if” for other fund companies as they watch on in anticipation, waiting to see more successes before jumping in with both feet.

A Sustainable Trend?

The sceptics talk about low capitalizations and poor inflows into the active ETFs on the market. Out of the 15 that exist, currently, only the Dent Tactical (DENT), the Pimco Enhanced Short Maturity (MINT) and the Pimco Intermediate Muni Bond (MUNI) have a market capitalization exceeding $10 million. It’s clear that the growth in the initial active ETFs to hit the market has been slow, though that is the case with most early starters in any industry. However, that is changing. DENT launched in Sep 2009 and already has a market cap of $26.5 million, while MINT which launched less than 2 months ago in Nov 2009 had $17 million by Dec 1^st and now has a cap of $52.1 million. This definitely has a lot to do with the impressive reputation of the providers but the growth is definitely picking up. And as more reputable names like T. Rowe Price, Vanguard and Claymore come to market, we might see this growth become exponential.

The real opportunity lies in the massive mutual fund industry. Currently, the mutual fund industry in the US manages more than $12 trillion, while the global mutual fund industry stands at $26 trillion. A large majority of these are actively managed mutual funds. According to BlackRock, the ETF industry just surpassed $1 trillion, most of which are passive, index tracking ETFs. In comparison, the active ETF market currently stands at around $140 million. The advantages of Active ETFs over mutual funds are many. And therein lies the opportunity.

Date Launched: September 16, 2009

Links: Website, Factsheet, Prospectus

Investment Strategy:

DENT is an actively managed fund of funds (more accurately, an ETF of ETFs) and invests primarily in other ETFs on the market. With a goal of long-term capital growth, DENT tries to identify “through proprietary economic and demographic analysis, the overall trend of the U.S. and global economies and how consumer spending patterns may change”. The portfolio managers use that analysis to invest in ETFs across different asset classes, including domestic and foreign equities, fixed income and commodities.

Portfolio Managers:

Harry S. Dent – Developer of “The Dent Method”, a forecasting approach based on demographic trends. Has several best sellers to his name and also publishes the HS Dent Forecast newsletter. Has been featured in television and written media numerous times.

Rodney Johnson – President of HS Dent Investment Management. Has worked with Harry Dent for more than 10 years, developing the Dent Method. Has been in the financial industry for over 20 years.

Past Performance –

1. The prospectus highlights the performance of a “Dent Strategic Portoflio” in the Northern Lights Variable Trust, which operates on very similar strategies as DENT and reported annualized returns of 12.35% in 2009, ending May 31, 09, outperforming the S&P500 by 10.58%.
2. The “AIM Dent Demographics Trend Fund” started off with a similar strategy in 1999 but in a 4-year period till 2004, it lost 11%, underperforming the S&P by about 9% per year.

The Numbers:

Gross Expense Ratio - 1.56%

Management Expense Ratio - 0.95%

Average Volume – 18,579 shares

What’s special about it?

1. Unlike any other existing Active ETF, DENT invests solely in other ETFs as opposed to individual securities. In other words, DENT resembles a fund of mutual funds, except it’s made up of ETFs which are supposedly cheaper and more liquid than mutual funds, hence benefitting investors. (or at least that’s the idea)
2. The fund can be long, short or in cash at any point, at the manager’s discretion and depending on the market conditions.
3. Investment strategy is based on 5 key attributes: Demographics, Tactical, Risk Mitigated, Expertise and Active.

Analysis:

Positives –

• Investing only in other broadly based ETFs instead of individual securities ensures there is sufficient diversification in the portfolio, since there would be no large single stock or sector bets. The fund has to be in 10 sectors.
• DENT has been the fastest growing Active ETF getting a lot of investor interest, trading over a million shares in its first 4 days, and is already the 2^nd largest Active ETF on the market with a market cap of around $26 million. The liquidity will help ensure spreads are not too wide.

Negatives –

• As a fund of ETFs, DENT might well be just layering on expenses on top of the expenses of underlying ETFs they invest in. A 1.56% expense can eat a big part of your return, especially in sideways markets.
• Whether or not a long-term, demographics based strategy is even relevant to current market conditions is debatable as investor sentiment and markets continue to be directed by short-term developments and government intervention.

Performance since inception vs S&P500: