What constitutes an actively managed exchange-traded fund? Getting definitions straight is the first challenge among many. For Deborah Fuhr, managing director and global head of ETF research and implementation strategy at BlackRock, if the strategy tracks a benchmark and goes outside the universe, say for rebalancing, then it’s not really active.
“I see actively managed ETFs as running a concentrated stock picking component,” she says. And herein lies a big challenge — active managers don’t want to tell everyone every day what they hold. “That’s the secret sauce,” she notes.
But to Noah Hamman, chief executive officer of AdvisorShares in Bethesda, Maryland, that’s somewhat splitting hairs. He agrees, though, that “passively tracking an index means very little buying and selling, but active ETFs can mean plenty of trading activity and so it’s not as tax efficient as index ETFs, but moreso than mutual funds.”
Challenge number three is taxes. And often, it depends on what active ETFs are being compared to. If it’s to other ETFs, it’s less tax efficient. If it’s to actively managed mutual funds, it’s more transparent and more tax efficient. On the positive side, Hamman notes that actively managed ETFs have been adopted much faster and have attracted more assets under management — $3.2 billion — than passive ETFs were when they were first introduced.
“Quantitative managers use their models to turn into indexes,” he says, “but now with active ETFs, they can turn the idea into an actively managed ETF, allowing tweaking and more flexibility.” And in his opinion, model-based or not, it can still be considered an actively managed ETF.
As for transparency, he states that when it’s your money, you want to look under the hood. “The biggest institutions demand transparency,” he says. And for smaller institutions, active ETFs hold the promise of access to great money managers while being able to run one’s own portfolio.
AdvisorShares’ WCM/BNY Mellon Focused Growth ADR ETF (AADR) has garnered a close to seven-year track record. “The managers have been doing a great job of beating their benchmark indexes by 10 percent, but the ETF, which on July 21 will be one-year-old, doesn’t have much of a track record yet,” says Hamman. It’s what BlackRock’s Fuhr refers to as the chicken-and-egg problem. “The ETF needs to get a following for it to attract more investors but they want to see a track record before investing,” she says.
Hamman is dismayed by the problem. “The product needs more shelf life perhaps,” he says, as to why AADR hasn’t attracted more investors as yet. But Kurt Winrich, co-CEO (with Paul Black) and chairman of WCM Investment Management of Laguna Beach, California, says that the active ETF version of his “fund”—“structurally, it’s called institutional separate accounts” — is in its infancy and that he expects it to take a little while until investors are comfortable with the product.
The portfolio is comprised of non-U.S. growth businesses, including consumer, technology and healthcare. “Our contention is that most international portfolios have a very definite value slant — energy, materials, etc. because that’s the majority of investment opportunities outside the U.S.,” he says, adding that it’s a concentrated (up to 30 holdings) portfolio with the catchphrase, “If you want to beat the index, you have to be different than the index.”
And then there are fees. According to Anthony Davidow, managing director, portfolio strategist at Rydex|SGI in New York — if an active manager is making 50 basis points, it will be much less for the ETF. A fact that WCM’s Winrich doesn’t disagree but notes the payoff should come with the promise of a lot more assets. “We get different exposure and see that it may be the solution for smaller, peripheral accounts. And we concede the tax efficiency issues, which may be a problem for a manager with high turnover, but in our case, we have very low turnover — the highest it’s ever been is 25 percent for a whole year, so there’s not much of a tax issue with our particular ETF.”
“We’ve been hearing for many years that active ETFs are coming, but they’re still not here,” adds Rydex’s Davidow, to which Winrich notes actively managed ETFs are not popular yet, but they will be.
Fees are higher than passive, says AdvisorShares’ Hamman, but lower than mutual funds. And when his largest fund, Cambria Global Tactical ETF (GTAA), crossed over $100 million in assets, the fees were lowered — from 1.35 to 90 basis points.
Both BlackRock’s Fuhr and FactorShares CEO Stuart Rosenthal, point out that actively managed ETFs represent is less than 1 percent of the entire ETF universe — total assets in U.S.-listed ETFs now total $1.083 trillion, with active funds comprising far less than 1 percent of assets with some closing. The announcement of the closing of two PowerShares Active ETFs near the end of June was noted because the company was the first ETF sponsor to issue actively managed ETFs. It will close two of its five actively managed funds by September 30.
In general, it hasn’t been a great time for active managers. But it also shows that despite the industry continuing to launch actively managed ETFs, they still haven’t garnered much of a following.
ETF Database notes there are currently 39 actively managed ETFs, with 13 equity and 13 fixed income, 10 currency and three alternative assets categories.
Another reason for the slow uptake of active ETFs is the opportunity for front running. Says Lawrence Carrel, author of ‘ETFs for the Long Run’ and the blog of the same name, “because of the transparency of holdings, traders can try to front-run the fund.”
WCM’s Winrich notes that it could be a potential issue if a portfolio manager is expecting to take multiple days to get into a position, say if working with smaller cap stocks, but with his own ETF, which deals with large-cap companies, it can buy the stocks it needs in one day.
Carrel notes that yes, in general, actively managed ETFs are a better deal than mutual funds, but investors are losing some benefits. However, he says, “there are only so many indexes—they’re becoming smaller and more niche-based, so how are ETFs going to continue to grow? Many folks are betting on active ETFs. “All indications are that they will comprise a bigger chunk of the ETF universe as soon as all the inner workings are figured out,” adds FactorShares’ Rosenthal.
