Is There a Case for Active Equity ETFs?

by: IndexUniverse

By Matt Hougan

T. Rowe Price (NASDAQ:TROW) is planning a full family of active ETFs. Will anybody care?

We’ve seen soooo much activity around active exchange-traded funds recently. There are now, by my count, a baker’s dozen actively managed ETFs on the market, including funds from PowerShares, Grail, AdvisorShares and Pimco.[1]

I think we’re just getting started. All four of those providers are considering additional funds, and companies like Vanguard, Claymore and BlackRock (NYSE:BLK) are eyeing the space. With T. Rowe Price tossing its hat into the ring, the real party is just beginning. I’m quite sure that executives at firms like Fidelity, Janus and American Funds are looking at T. Rowe’s filings and wondering if they are missing the boat.

Altogether, I wouldn’t be surprised if 100 actively managed ETFs were on the market next year.

What would surprise me is if they had any assets.

The record so far isn’t good. The 13 actively managed ETFs I track have a combined $83 million in assets, or an average $6.4 million per fund. Eleven of the funds are well below the $10 million cutoff line where you start to worry about funds closing.

Actively Managed ETFs: Dec. 1, 2009





Fund Flows


Grail American Beacon Large Cap Value




Grail RP Growth




Grail RP Technology




Grail RP Focused LargeCap Growth




Grail RP Financials




AdvisorShares Dent Tactical




PowerShares Active U.S. Real Estate




PowerShares Active Low Duration




PowerShares Active Alpha Multi-Cap




PowerShares Active Alpha Q




PowerShares Active Mega-Cap




Pimco Enhanced Short Maturity




Pimco Intermediate Municipal Bond*







Source: NSX. Data as of 11/30/09.

*Launched Dec. 2, 2009

The only fund that’s really off to a decent start assetwise is MINT, which only debuted in late November and already has $17 million in assets. My guess is that a fund like MINT, backed by a name like Pimco, will eventually attract significant assets. For the others, who knows?

The problem, as I and others have said many times before, is that actively managed mutual funds are sold on either commission-based sales loads or on track record. ETFs have neither.

The sales load problem is intractable. There are dirty tricks that fund companies can use to attach sales loads onto ETF-like structures (by launching something as a loaded closed-end fund with a timed conversion to an ETF structure, for instance); fortunately, no one has done that yet in the U.S.

The track record problem is a bit easier to solve—you can just wait it out and see if the cream rises to the top. But even here, there are challenges.

A fund company can launch a traditional mutual fund and wait three years for it to generate a track record. If it does well, the company can market it aggressively; if not, it can simply close it and sweep the debris under the rug. Investors who buy into the fund during the early years participate in its performance fair and square.

With ETFs, it’s more of a challenge. ETFs with small asset bases tend to trade with wide bid/ask spreads. If actively managed ETFs need to wait three years to accumulate a track record, early investors are going to suffer from wide bid/ask spreads when they buy and sell. And that will be hard for many fund companies to stomach.

I’d love to see actively managed ETFs take off. In the equity space, actively managed ETFs are simply a better mousetrap than actively managed mutual funds. All of the things that make ETFs great—lower costs, more tax efficiency, etc.—are of amplified performance in the active market. If active mutual fund investors switched en masse to actively managed ETFs, they would be better off.

But I’m skeptical we’ll see much growth anytime soon. It just runs counter to how active funds are distributed.

The areas where I think active may take off are the areas of the market where the case for active management is the strongest. I’m shocked that there is not yet an actively managed commodity futures ETF, as that is a market where a strong case can be made for active management. Similarly, I think there are cases to be made in parts of the fixed-income market for a kind of “active-lite” approach.

But regular equities? I think the case remains to be seen.


1. WisdomTree’s (WSDT.PK) currency ETFs are technically “actively managed.” I don’t count these in my tally of actively managed funds, as most investors think of the funds as providing exposure to currency exchange rates. They are not “active funds” in the minds of investors, even if the underlying strategy is actively managed.

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