However, if you include index-based ETFs that incorporate elements of active management in their benchmarks, then you could argue that active ETFs have already made a big impact on the landscape. And if you're looking for name recognition, a planned ETF version of PIMCO's Total Return Fund would bring bond guru Bill Gross into the active ETF fold, too.
An actively managed ETF is one that has an individual or team making day-to-day decisions about the portfolio and trading securities. In other words, it is not the passive investment strategy tracking an index that most ETFs use. The managers make changes to sector allocations or deviate from a benchmark index with their own investment style and research. Currently, there are fewer than 30 truly active ETFs, but the category represents a major potential growth area for exchange-traded products, which are already the hottest investment vehicles on Wall Street.
"It's a question of when, not if, active ETFs will be part of the landscape," said Tony Rochte, the senior managing director of State Street Global Advisors, at Morningstar's recent ETF conference in Chicago.
While more than 800 active ETFs have been filed with the SEC, Rochte points out that less than 1% of total ETF assets are in active products.
Sue Thompson, head of BlackRock's registered investment advisor group and 401(k) sales, says active ETFs will grow, but regulatory approval will take time. Noah Hamman, the chief executive officer of AdvisorShares, has stated that fewer companies are launching actively managed ETFs under the heightened regulatory scrutiny, and the SEC is taking longer to grant firms exemptive relief. Also, the agency has placed a moratorium on new ETFs that invest in derivatives in the wake of the financial crisis.
Active ETFs still have to overcome some obstacles, says Rick Genoni, the principal and head of Vanguard's ETF product management department. For an ETF to trade properly, its holdings have to be transparent. Active managers, however, don't want to tip their hand on trades. So firms are working on structures for active ETFs that offer the necessary disclosure without exposing the manager to front runners.
Genoni also noted that there are three subcategories of active ETFs: pure active funds, funds of funds, and active strategies rolled into rules-based indices. Since active funds usually spend more time in the regulatory approval pipeline, some firms have instead launched ETFs that wrap active strategies into a quantitative, rules-based index.
The first of the rules-based ETFs have selected high-dividend stocks, utilized technical analysis and weighted companies by other fundamental factors such as earnings or valuation. A growing class of ETFs is now offering a form of strategy-based methodology that mimics decisions made by active managers. However, instead of following the specific decisions of a manager, these types of ETFs track hand-tailored indices that screen for specific qualities in component holdings in an attempt to beat the market.
These ETFs often focus on smaller benchmarks that closely follow specific market factors like the analysis of public company filings relative to frequency of trades, purchases of stocks and increases in holdings by a firm's insiders, as well as data screening strategies that look for earnings analysis based on a company's returns.