Active Funds Vs. Index ETFs

Includes: ELD, MINT
by: Tom Lydon

The actively managed exchange traded fund space only makes up a fraction of the overall industry, but with big-name players expanding into the space, like PIMCO, we may begin to see a rapid explosion of prominent managers lending their expertise to ETF investments. However, there is a catch.

The new wave of actively managed ETFs will have managers guiding the funds to achieve high performance, but they may work around transparency rules and limit their disclosures into holdings, reports Murray Coleman for the Wall Street Journal.

Daily disclosure in passively indexed ETFs is a given as fund sponsors need to show daily holdings to market makers, or "authorized participants," to create or redeem ETF shares, which help keep ETF prices close to their net asset values.

Active managers, though, don't like to reveal their secret sauce.

"The concern is that competitors such as hedge funds and high-frequency traders will front-run their portfolios," consultant Christian Magoon, former president of Claymore Securities, said in the article. Front-running refers to how individuals may ascertain a manager's position and start buying or selling the same position ahead of the active manager.

Magoon notes that while smaller actively managed ETF providers have been allowing full transparency, big-name stock pickers may not want to fully disclose their positions.

"The active ETF marketplace needs to attract more big-name stock-fund managers to gain traction with mainstream fund investors," Magoon added.

The actively managed ETF space accounts for less than 0.5% of the $1.2 trillion U.S. ETF market. The largest actively managed ETFs track bonds, including the PIMCO Enhanced Short Maturity Strategy Fund (NYSEARCA:MINT) and the WisdomTree Emerging Markets Local Debt Fund (NYSEARCA:ELD). Disclosure in bonds is less of a problem since it is harder to replicate.

"Fixed-income opportunities tend to be broader, and each security carries its own set of subtle characteristics, which can enable an experienced active manager to add value," Don Suskind, head of ETF product management at Pacific Investment Management Co., said in the article.

Navigate Fund Solutions, a subsidiary of Eaton Vance, is developing a hybrid process called exchange traded managed funds, or EMTFs, as a solution to the dilemma. Managers would not publicize positions being initiated or bumped until trades are settled, and investors would not know the exact value of shares until the market closes.

Last August, BlackRock has filed with the SEC to launch active ETFs that wouldn't follow current daily disclosure practices and operate from a blind trust.

Guggenheim Investments has proposed a proxy portfolio that would closely mimic an ETF's actual movements through the course of a trading day but specific holdings would be different.

Max Chen contributed to this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.