Active ETFs: Full Steam Ahead

by on July 9, 2009 | ETFs Mentioned:

Although ETFs and mutual funds seem in many ways to be natural rivals, one of the most closely-watched trends in the “active vs. passive” debate has been the development of a hybrid type of investment option: actively-managed ETFs. While the space has mostly taken “baby steps” to this point, it appears to be poised for explosive growth in the coming months.

Pioneering PowerShares

Bear Stearns actually launched the first actively-managed ETF in March 2008, but the issuance was overshadowed by the brokerage house’s impending demise, and the fund (YYY) shut down less than six months later. Invesco PowerShares is the true pioneer of the actively-managed ETF space, launching four ETFs (PQY, PQZ, PMA, and PLK) in April 2008. Based on proprietary quantitative methodologies, these ETFs were the first to deviate from a predetermined, static index. Originally, the four PowerShares ETFs imposed limitations on the timing and frequency of trading, although such restrictions have since been relaxed. PowerShares subsequently introduced an actively-managed real estate ETF (PSR).

While all five of these original funds are still traded, they have struggled somewhat to attract investor funds, with combined total assets of about $22 million according to the latest NSX data. But according to a recent Wall Street Journal article, PowerShares didn’t necessarily expect these funds to gain huge market share overnight. “We never expected that active ETFs would be the Holy Grail,” notes Ed McRedmond, senior vice president of portfolio strategies at Invesco PowerShares. Rather, PowerShares anticipated a long introduction period over which the firm would be able to prove the cost and tax advantages of its products. Since their inception, the performance of these funds has been mixed: PMA is ahead of its benchmark, while PQZ trails.

Along Came Grail

Earlier this year, Grail Advisors launched the Grail American Beacon Large Cap Value ETF (GVT), the first truly actively-managed ETF (in the sense that it does not rely on proprietary models, but rather affords its managers total discretion in buy and sell decisions). While the initial response to GVT was lukewarm, the fund has gathered some momentum in recent weeks, and its success was enough for Grail to file for four additional actively-managed ETFs, each of which would have a single manager (GVT has three managers in order to address frontrunning issues arising from its disclosure requirements).

Next Up: The “Big Dogs”

While no one knows with certainty what the future holds for the actively-managed ETF industry, all indications are that the space is going to get very crowded very quickly. In addition to the additional funds in the works from Grail, a number of other fund issuers have announced their intentions to enter the arena. Claymore Securities, known for its line of ETFs based on “smart” indexes, recently filed to launch three actively-managed funds, including the first actively-managed commodity ETF.  In addition, Claymore has been waiting for approval on an actively-managed “nontransparent” equity ETF. Hedge fund ETFs have also been gaining traction, with IndexIQ and WisdomTree leading the way.

To date, the early leaders in the actively-managed ETF race have excluded the industry’s three leading issuers, but that may be about to change. Vanguard has filed for four actively-managed ETFs, each of which would be tied to existing bond indexes. Market leader iShares has also filed to launch multiple active ETFs, including both stock and bond funds. And with the completion of its sale to BlackRock, a leader in the active management business, it seems likely that iShares will be pushing actively-managed products sooner rather than later. Similar speculation has been aired over PIMCO, the bond fund giant that launched its first ETF last month. A stellar reception to TUZ has led many to believe that star manager Bill Gross will be soon be the face of the actively-managed bond ETF game.

Disclosure: No positions at time of writing.