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The Arrival of Active ETFs

|Includes: AdvisorShares Dent Tactical ETF (DENT), MINT, MUNI

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 (NYSEARCA: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 (NASDAQ:DENT), the Pimco Enhanced Short Maturity (NYSEARCA:MINT) and the Pimco Intermediate Muni Bond (NYSEARCA: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 1st 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.

Disclosure: No positions in Active ETFs.