The world’s first actively managed exchange-traded fund (ETF) – the industry’s long sought-after “holy grail” has finally been realized at last, or so the industry would have you believe.
After years of discussion between fund sponsors and regulators, the ETF sector finally has its first actively managed ETFs. Invesco PowerShares last week launched four new ETFs on the New York Stock Exchange, after being granted regulatory approval.
Since the very first ETF was launched 15 years ago they have quickly become one of the hottest investment vehicles of all time. Assets under management in ETFs soared 30% last year alone to nearly $560 billion. ETFs have proven especially popular among affluent investors.
It’s worth noting here that the very first ETF launched in 1993 was designed to track the S&P 500 Index. That’s been one of the key advantages to ETFs all along. That’s a key advantage that actively managed ETFs don’t have in their favor.
Index Tracking ETFs Keep Costs Low
Up until now, each of the hundreds of ETFs listed is designed to track an index. There are ETFs that track stock indexes, ETFs that follow bond indexes, ETFs that track commodities, real estate, specific sectors… you name it.
Index tracking ETFs, like the Vanguard index mutual funds that came before them, are very low cost investments. No active management means no high management fees. As a result, the average expense ratio for ETFs is less than 0.4%, while actively managed mutual fund expenses average 1.2% -- three times higher!
Investors are attracted to ETFs for this very reason (among others)… low fees. Lower fees mean higher investment returns. Compound that over enough years in the market, and it’s easy to see why index ETFs are so appealing. In fact, they tend to outperform most mutual funds.
Who Needs Actively Managed ETFs Anyway?
According to Bruce Bond, CEO of PowerShares, the introduction of actively managed ETFs “is a watershed event for the industry because people have not had access to active management within the ETF structure before now.” Bond claims that active ETFs will transform the industry landscape. Somehow, I seriously doubt that.
There are more than 10,000 conventional mutual funds in existence today. The vast majority of these are actively managed funds, with high-priced fund managers collecting fat fees in return for their investment skills.
Sadly, over 90% of these actively managed mutual funds cannot beat the market index return; most fall well short in fact. In other words, investors are paying higher management fees for nothing. No wonder index-tracking ETFs are so popular.
Other big advantages of ETFs are liquidity and transparency. Actively managed mutual funds can only be bought once a day, at the end of the day, when financial markets are closed. ETFs by contrast are listed on major stock exchanges and can be bought and sold throughout the trading day, minute by minute, and tick by tick.
Transparency: Another Key Advantage is a Roadblock for Actively Managed ETFs
With ETFs you always know what you own. That’s because regulators require ETF sponsors to disclose all their positions every day. Mutual funds are only required to disclose fund holdings once every six months.
One of the stumbling blocks that PowerShares new actively managed ETFs had to overcome was this transparency issue. Active fund managers – that is the few ace managers who actually can beat the market – like to keep their investment strategies under wraps to some extent. If other investors could plainly see what they’re buying then those stocks would shoot higher, eliminating the active manager’s edge.
According to one industry expert, if “you talk to any active manager that actually has skill, they don't want to disclose what they have every day… that’s the last thing any money manager wants.”
As a result, I very much doubt that actively managed ETFs will attract many talented money managers who could earn much more money by running traditional mutual funds (not to mention hedge funds). Far from being a “watershed event”, the holy grail of actively managed ETFs just doesn’t make much sense to me.
Instead of transforming the industry, active ETFs look like they’re dead-on-arrival in my opinion.
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