Active ETF Pipeline: Previewing Some Exciting Funds On The Horizon

by on October 4, 2010 | ETFs Mentioned:

With the first three quarters of the year now in the books, 2010 has so far seen a continued expansion of the ETF industry; more than 100 new funds have launched and assets have climbed closer to $1 trillion in total. But some corners of the industry that had been pegged as major sources of growth have struggled to gain traction. Active ETFs in particular have been generally slow to accumulate assets, as investors who believe that managers can add alpha have continued to embrace mutual funds.

Currently, there are nine actively-managed equity ETFs on the market, including funds from PowerShares, Grail, and AdvisorShares. Aggregate assets in those nine funds currently stands at about only $100 million, a somewhat disappointing total considering the potential for this space (as measured by mutual fund assets) and the significant amount of hype surrounding the marriage of active management and the ETF structure.

But despite the slow start, there are reasons to believe that the future remains bright for active ETFs. A number of traditional mutual fund companies have filed for exemptive relief that would allow them to test the ETF waters, a move that could bring an increase in interest and a flood of new assets. And the issuers already in the active ETF space have been busy laying the groundwork for some pretty intriguing new products, including some that will introduce superstar managers to the ETF space and others that will implement strategies that have proven tremendously popular in mutual fund form. While there are dozens of active ETFs in registration, we profile four of the most exciting products coming down the pipeline that could hit the market in the fourth quarter of this year:

Grail/DoubleLine Emerging Markets Bond ETF

Grail Advisors, the San Francisco-based firm that last year launched what many consider to be the first true actively-managed ETF, recently inked a major partnership that could translate into huge success in the active ETF space. In June, Grail announced that it would team up with DoubleLine Capital, the firm founded by former TCW bond fund star Jeffrey Gundlach after a rather eventful separation from his previous employer. First up is the Grail DoubleLine Emerging Markets Fixed Income ETF, a fund that will focus on an asset class in which many investors are willing to pay for the experience of an experienced management team [see Grail + DoubleLine = ETF Gamechanger?].

The proposed emerging markets debt fund, which is currently making its way through the SEC, will be managed by a DoubleLine team headed by Luz Padilla that has been working together for more than a decade. This ETF could represent the first time that a true superstar manager has waded into the ETF waters; this side of Bill Gross, there is perhaps no bond investor more respected than Gundlach. The ETF would also be targeting a corner of the fixed income market that is red hot at present; recent launched from WisdomTree (ELD) and Van Eck (EMLC) have raked in huge amounts of assets in a relatively short period of time.

The proposed fund would charge an expense ratio of 95 basis points; currently the average for the Emerging Markets Bond ETFdb Category stands at 0.54% [see the prospectus filed with the SEC].

Cambria Global Tactical ETF (GTAA)

AdvisorShares has found some early success in the active ETF space, as the firm’s long/short ETF (GRV) currently has about $40 million in assets. AdvisorShares is poised to expand its active ETF product line in coming months, partnering with a number of well-known investors in the process. One product in the pipeline is the Cambria Global Tactical ETF (GTAA), which will be structured as an ETF-of-ETFs and will invest in all major asset classes across the globe.

GTAA will be managed by Cambria Investment Management, with Mebane Faber and Eric Richardson–authors of the influential The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets–serving as portfolio managers. In their book, Faber and Richardson outlined the investment strategies of endowments at Yale and Harvard, providing an ETF-based asset allocation approach that individual investors could scale to their own portfolios.

Faber has conducted extensive research in an effort to devise a quantitative methodology that delivers equity-like returns with bond-like volatility and drawdown, and the forthcoming active ETF from AdvisorShares will be built around those methodologies. According to the prospectus, GTAA’s investment objective is to “preserve and grow capital from investments in the U.S. and foreign equity, fixed income, commodity and currency markets, independent of market direction.”

GTAA will charge an expense ratio of 1.35% [see Quant ETFs In Focus: Seven Funds Delivering Big Gains].

Peritus High Yield ETF (HYLD)

Also on the horizon for AdvisorShares is an active ETF focusing on the high yield corner of the bond market; the Peritus High Yield ETF (HYLD) will seek to deliver returns greater than that Barclays Capital U.S. High Yield Index. Peritus’ strategy involves a “value-based, active credit approach to the markets” that generally ignores new issue participation in favor of the secondary market where the firm believes more capital gains opportunities exist [also see Investors Can't Get Enough Of Junk Bond ETFs].

Peritus places limited value on the ratings assigned by firms such as Moody’s and Fitch, believing that these agencies “lag the market perception of risk and often ignore critical components of a company’s credit profile.” According to the fund’s fact sheet, HYLD may from time to time utilize Treasuries as a tool for protecting against adverse market conditions, potentially profiting from a “flight to quality” (while, of course, also potentially giving up the higher yields of junk bonds).

The junk bond corner of the ETF market is a bit perplexing at present; there is very clear investor interest in the asset class–assets in junk bond ETFs exceed $12 billion–but only three funds currently offering exposure (JNK, HYG, PHB). HYLD will charge an expense ratio of 1.35%; currently the average for the High Yield Bonds ETFdb Category stands at 0.47%.

Active Bear ETF (HDGE)

One of the more unique active ETF products making its way through the approval process, HDGE’s focus will be short selling a portfolio of mid-cap and large cap stocks, ETFs, and ETNs in an attempt to generate capital appreciation. According to the prospectus, the fund manager will implement a “bottom-up, fundamental, research driven security selection process that seeks to identify securities with low earnings quality or aggressive accounting that may tend to mask operational deterioration and bolster the reported earnings per share over a short time period.” The sub-advisor, Ranger Alternative Management, will also focus on earnings-driven events–such as downward revisions or reduced forward outlooks–that could lead to a price decline [read A Closer Look At Hedge Fund ETFs].

The prospectus for the fund shows some recent history for a Ranger fund with a similar investment objective; in 2008, the Ranger Short Only Portfolio gained a whopping 95% (the S&P 500 lost about 37% that year). Last year, however, was a different story as a rally in equity markets sent the short only fund down nearly 30% (the S&P 500 gained more than 26% in 2009).

HDGE will hold between 20 and 50 short positions, with each accounting for between 2% and 7% of the total portfolio position. The fund will charge an expense ratio of 1.85%, which would make it one of the most expensive ETF products on the market [see the most recent HDGE prospectus].

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Disclosure: No positions at time of writing.