Actively Managed ETFs Are Coming. Should You Invest?
July 20, 2007
Rob Wherry at Smartmoney says that actively managed exchange traded funds could start appearing as early as this year. Actively managed ETFs are those in which fund managers actually decide which securities to buy, unlike existing ETFs that passively track an index like the S&P 500. But despite planned launches by some of the biggest names in the fund industry, questions about exactly how actively managed ETFs will work remain.
When and if these actively managed ETFs hit the Street, investors will need to ignore the hype and ask some tough questions about their construction, their costs and whether they make a good fit in their portfolios. 'I think it's the next logical step,' says Scot Stark, founder of Stark Strategic Capital Management outside Baltimore. 'But if the costs are too high it could be one of those crazes that hits the market and eventually falls off the radar screen.'
ETFs were first conceived almost 15 years ago, but fund families are just now pulling off an actively managed version. One major obstacle: How to provide a transparent portfolio that can be valued accurately at any point in a trading day. Existing ETFs can easily be priced because they track established benchmarks that rarely switch out their members. The manager of an active ETF, though, could decide to buy or sell a stock on any given day, making it much more difficult to track the fund's holdings and its value. The problem is only exacerbated by the fact that most managers don't like to tip their hands about their trades for fear that savvy investors could front run those bets and diminish their returns. That secrecy makes it hard for the active ETF's market makers — the entities that facilitate its trading — who need to know what has changed in the portfolio to create or redeem shares.
A possible solution is to use an intermediary to set up a kind of a tracking index that would reveal some of a fund's holdings while keeping other positions under wraps. But if that winds up keeping the portfolio secret for long periods of time it would eat away at one of the ETF's biggest benefits. Financial advisors like ETFs because they know exactly what's in a given fund's basket of stocks, allowing them to plug holes in a client portfolio that may need some added diversification. What's more, if managers are trading stocks when they rise or fall, that could lead to higher annual costs and less tax efficiency — two calling cards of the ETF industry."
Frankly, some current ETFs are so strange they are basically actively managed anyway. Some have higher turnover ratios (a measure of how often the holdings in the portfolio are changed) than actively managed funds. Many of these newfangled ETFs are based on custom or rule based indexes – not traditional indexes. If the company behind the ETF is designing the index the ETF mimics – isn’t it actively managed?
We currently use several old-fashioned passively managed exchange traded funds in our client portfolios and in the MAXadvisor Powerfund Portfolios, we're going to take a wait and see approach to these new actively managed ETFs. If we determine they offer a cheap and effective alternative to traditional mutual funds, we'll consider them.
Rob Wherry at Smartmoney says that actively managed exchange traded funds could start appearing as early as this year. Actively managed ETFs are those in which fund managers actually decide which securities to buy, unlike existing ETFs that passively track an index like the S&P 500. But despite planned launches by some of the biggest names in the fund industry, questions about exactly how actively managed ETFs will work remain.
When and if these actively managed ETFs hit the Street, investors will need to ignore the hype and ask some tough questions about their construction, their costs and whether they make a good fit in their portfolios. 'I think it's the next logical step,' says Scot Stark, founder of Stark Strategic Capital Management outside Baltimore. 'But if the costs are too high it could be one of those crazes that hits the market and eventually falls off the radar screen.'
ETFs were first conceived almost 15 years ago, but fund families are just now pulling off an actively managed version. One major obstacle: How to provide a transparent portfolio that can be valued accurately at any point in a trading day. Existing ETFs can easily be priced because they track established benchmarks that rarely switch out their members. The manager of an active ETF, though, could decide to buy or sell a stock on any given day, making it much more difficult to track the fund's holdings and its value. The problem is only exacerbated by the fact that most managers don't like to tip their hands about their trades for fear that savvy investors could front run those bets and diminish their returns. That secrecy makes it hard for the active ETF's market makers — the entities that facilitate its trading — who need to know what has changed in the portfolio to create or redeem shares.
A possible solution is to use an intermediary to set up a kind of a tracking index that would reveal some of a fund's holdings while keeping other positions under wraps. But if that winds up keeping the portfolio secret for long periods of time it would eat away at one of the ETF's biggest benefits. Financial advisors like ETFs because they know exactly what's in a given fund's basket of stocks, allowing them to plug holes in a client portfolio that may need some added diversification. What's more, if managers are trading stocks when they rise or fall, that could lead to higher annual costs and less tax efficiency — two calling cards of the ETF industry."
Frankly, some current ETFs are so strange they are basically actively managed anyway. Some have higher turnover ratios (a measure of how often the holdings in the portfolio are changed) than actively managed funds. Many of these newfangled ETFs are based on custom or rule based indexes – not traditional indexes. If the company behind the ETF is designing the index the ETF mimics – isn’t it actively managed?
We currently use several old-fashioned passively managed exchange traded funds in our client portfolios and in the MAXadvisor Powerfund Portfolios, we're going to take a wait and see approach to these new actively managed ETFs. If we determine they offer a cheap and effective alternative to traditional mutual funds, we'll consider them.
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