Will Legg Mason Jumpstart Actively-Managed ETFs?

by on February 24, 2010 | ETFs Mentioned:

Legg Mason appears ready to make its long anticipated move into the active ETF space. The Baltimore-based asset management firm filed for approval with the SEC that would allow it to introduce actively-managed ETFs to U.S. markets. Filing for exemptive relief is one of the first steps on the road to launching ETFs, and requires very little in the way of disclosure from would-be ETF issuers. Legg’s filing mentioned that potential ETF products could include domestic equities, global equities, and fixed income funds, but didn’t specify beyond that or indicate which products may be first up.

“Legg Mason’s plan to get into the rapidly expanding ETF industry comes on the heels of a year that saw several fund industry giants toss their hats into the ETF ring,” writes John Gabriel for Morningstar. “After dragging their feet for several years, many fund companies are now embracing the opportunity to capture a slice of one of the most popular and fastest-growing segments of the asset-management industry.” Legg joins T. Rowe Price, PIMCO, and Goldman Sachs as major players in the financial services industry gearing up for a run at actively-managed funds.

Slow Start, Huge Potential

The first actively-managed ETF was launched in March 2008 by a most unlikely issuer: Bear Stearns debuted the Current Yield ETF (YYY) just before collapsing. JP Morgan kept YYY around for a while, but ultimately pulled the plug. The next pioneer PowerShares, which launched four active ETFs in April 2008 and another in November of that year. In May of 2009, Grail Advisors entered a new frontier of the actively-managed ETF space by launching the American Beacon Large Cap Value ETF (GVT). Unlike the PowerShares active products, which rely primarily on quantitative analysis, GVT allows manager discretion in the selection of its underlying holdings, making it the first true active ETF in the eyes of many investors. Grail has since expanded its product line to seven funds, including two bond and five equity ETFs.

When Grail launched GVT, many industry analysts (ETF Database included) anticipated an opening of the floodgates. But the surge in active ETFs is yet to materialize, as the active ETF space remains a relatively small community. In addition to the funds from PowerShares and Grail, AdvisorShares offers the Dent Tactical ETF (DENT) and PIMCO has launched three active bond funds (MINT, SMMU, and MUNI). WisdomTree also maintains a line of actively-managed currency products. In total, only about 3% of the ETFs in the ETF screener are active, and these funds account for a much smaller percentage of total ETF assets.

Despite the relatively slow start, there are plenty of reasons to believe that actively-managed ETFs will see a surge in use in coming years. It’s important to remember that the first passively-managed ETF was launched in 1993, and the industry didn’t enter its “golden age” until more than a decade later. Mutual funds aren’t going to give up ground to ETFs without a fight. But the attractive aspects of passive ETFs–lower costs and potential for enhanced tax efficiency–are still very applicable and achievable in an active setting. Moreover, the “disclosure dilemma” that many advisors worried would be an insurmountable obstacle has been proven to be a non-issue, a fact that should increase the comfort level of advisors when using active ETF products.

The entrance of firms like T. Rowe and Legg into the space would likely provide a nice boost, just as PIMCO’s foray into the space did for active bond ETFs. But the real gamechanger may come from an issuer already very active in the space: Grail is reportedly near a deal to convert an established mutual fund to an actively-managed ETF. If such an arrangement proves to be successful, the active ETF space could potentially skip through the growing pains endured by other areas of the ETF market, and assets could surge overnight.

Stay tuned – the corner of the ETF industry could become very active very quickly.

For updates on active ETFs and other developments in the industry, sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.