Active exchange-traded funds seemingly provide the best of both worlds, offering fund manager expertise with the lower cost structure of ETFs. Yet eight years after the first such fund was launched, the 150 active ETFs currently trading have yet to deeply resonate with investors. They represent just one percent of assets in the $2 trillion domestic ETF market.
Will a recent SEC ruling create the opening these funds need to thrive? Yes, to an extent, say industry experts.
In late July, the U.S. Securities and Exchange Commission allowed for a greatly streamlined approval process for new active ETFs. What used to take months will now take weeks. “This is good news for asset management firms, which can get new funds to market soon after they are devised,” says Todd Rosenbluth, director of ETF and mutual fund research at S&P Global Market Intelligence.
But the SEC didn’t address another area of concern for fund firms: non-transparency. Part of the appeal of passive ETFs stems from investors’ ability to know what a fund owns every day. Requiring managers of active ETFs to disclose updated positions on a daily basis brings an unwanted result. “It can take several weeks for a fund manager to build a position in a stock, and he doesn’t want others seeing his moves and start front-running him,” says Alex Bryan director of passive strategies research, North America at Morningstar. He adds that active ETF managers also have the same concern as they slowly exit a stock position.
Still it’s clear that many fund companies would like to make a bigger push into active ETFs. “If regulatory guidance changes [and the SEC allows active ETF fund managers to avoid daily disclosure], you’ll see a lot of new active ETF launches,” Bryan says.
Deborah Fuhr, co-founder and managing partner at London-based fund research firm ETFGI, notes that roughly 40 firms have filed for approval to launch active ETFs, albeit with a non-transparent structure. Those firms include Gamco Investors, American Beacon, and Hartford Financial Services Group. “It’s an open question whether the SEC will approve these applications,” Fuhr says.
Of course, if the fund companies get the green light and many new active ETFs are launched, these firms will be dogged by the same questions that are hitting hedge funds and mutual funds these days. “Many active managers don’t deliver alpha. The majority are not beating their benchmarks,” says Fuhr. Adding insult, while active ETFs typically have expenses that are 0.60 percentage points lower than mutual fund peers, they’re still not as cheap as passive ETFs.
The ETMF Twist
Firms can get around the SEC disclosure issue by launching a slightly different kind of fund, known as an Exchange-Traded Managed Fund (ETMF). These funds also provide active management, but with an ETF cost structure, while still providing only a quarterly update to their holdings.
Yet these funds also have drawbacks. Like closed-end mutual funds, they generate a daily net asset value (NAV). To account for intra-day purchase and sales of these funds, they must be priced in a range around the prior day’s closing price, give or take a few cents. That's a more complex pricing process than traditional ETFs, and may not be easily understood by some advisors and investors. ETFGI’s Fuhr adds that “the SEC wants these clearly labeled as ETMFs” so they are not confused by investors with plain vanilla ETFs.