Hand-Wringing Over Active ETFs and New Vanguard Bond ETFs

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Includes: BIV, BLV, BND, BSV
by: Carl T. Delfeld

The move by investment firm Bear Sterns to file a prospectus for an actively managed ETF will bring a lot of hand wringing. This development does break new ground and likely marks the beginning of further attempts to sponsor ETFs focused on providing investors with alpha performance. Jonathan Bernstein, ETFzone Trading Specialist discusses this issue and like many others seems concerned at the prospect of actively managed ETFs.

I do not share their concerns.

First of all, in my view we already have actively managed ETFs such as many of the Powershares ETFs. The selection and weighting of companies in their ETF baskets are generated by a model which investors do not have access to and therefore accept on faith.

Secondly, investors, financial advisors, and financial publishers like the Chartwell ETF Advisor actively trade ETFs in the portfolios they build or publish for investors. Pure indexers would frown on this practice seeing index products like ETFs as buy and hold investment tools.

Let the investors decide what works best. Some of the Powershares turnover rates are over 100% which will of course negatively affect their tax efficiency. This plus low costs and transparency are what started the ETF revolution in the first place. Why would an investor prefer an actively managed ETF over an actively managed mutual fund? We will see but there is no need to panic.

The Simplicity of New Vanguard ETFs

Some are questioning the value of the four new bond exchange-traded funds introduced by Vanguard this week . Mark Hulbert of MarketWatch comments in a good article that "try as I might, I don't see how or why the world will be better off because of these new funds."

Mark then goes on to mention a few possible reasons such as slightly lower fees. What I like about these new ETFs is their simplicity and that they will encourage individual ETF investors to get more fixed-income into their portfolios. Most investors need a limited menu and while iShares offers more bond ETF choices, this also leads to confusion and indecision by most investors.

Vanguard also states that the diversification within its bond ETFs helps keep tracking tight and default risk low. The Vanguard Total Bond Market ETF (NYSEARCA:BND) holds more than 20 times the number of bonds of its competitor’s iShares product. In addition, the estimated expense ratio for each of its new bond ETFs is 0.11%. That's nearly 40% below the average for competing ETFs.

I don't think most individual investors will trade these new ETFs but will rather use them as core holdings.

Here are the names and tickers for the new Vanguard bond ETFs.

Total Bond Market ETF (BND)
Short-Term Bond ETF (NYSEARCA:BSV)
Intermediate-Term Bond ETF (NYSEARCA:BIV)
Long-Term Bond ETF (NYSEARCA:BLV)

Clean and simple, like I like it. Vanguard is definitely targeting the individual investor just as iShares leans more to the institutional investor.

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