Step Aside, Bill Gross: In Search of the New ETF Rock Stars

Trend-watching pundits at Morningstar ETF Invest say active management of smart-beta equity ETFs is what's next

Where are the rock stars in the world of exchange-traded funds?

This was the big question on the minds of trend-watching ETF pundits as they brought the Morningstar ETF Invest Conference 2013 to a close on Friday.

While the pundits agreed that Bill Gross, manager of the PIMCO Total Return ETF (BOND), is the biggest “rock star” in the fixed-income space, they also concurred that active management of “smart beta” equity ETFs will be the next big trend.

So step aside, Mr. Gross, said ETF media mavens Matt Hougan of IndexUniverse and Tom Lydon of ETF Trends at Morningstar’s “Meet the Pundits” panel on Friday. Your days as the biggest rock star in the ETF universe are numbered as smart beta awaits the emergence of rock-star equity ETF managers who will make as big a splash as rock-star mutual fund managers did in the 1980s. (Think Sir John Templeton’s Growth Fund and John Neff’s Windsor Fund.)

“The ETF business is boring. Bill Gross is our rock star. We need to do better,” Lydon said at the panel that moderator Brendan Conway of Barron’s characterized as a “no-holds-barred, rapid-fire” review of all things ETF.

Lydon wrote an ETF Trends comment in September that looks at trends such as the growing number of quasi-actively managed strategies, or factor strategies, that use enhanced, smart-beta indexing methodologies. On Friday, he noted that as ETFs have grown in popularity over the last 20 years, ETF and index providers’ initial expectation that active management would be the next big thing has given way to “active management in a smart beta deliverable.”

While Hougan predicted that the next rock stars will be found among the ETF portfolio strategists and not the fund managers, Morningstar’s passive funds research director Ben Johnson, also on the pundits panel, said that ETF managed portfolio growth has been phenomenal. Morningstar data now puts these portfolios at a total of $80 billion, “and it’s growing at a really rapid clip,” Johnson said.

(Indeed, Morningstar is looking to add a “smart beta” category winner to its ETF awards next year, but it’s not thrilled with the term, said alternative investment researcher Scott Burns, who pointed out that smart beta assumes that there’s also “dumb beta” kicking around the ETF universe.)

With the rapid rise in smart beta ETFs, Conway pointed out that the trend has laden investors down with a lot of new information to digest. “How do you distinguish from marketing and what really works? How do you kick the tires?” he asked.

“It’s time to go back to school, quite frankly,” Johnson answered. “This is some dense stuff” that’s rooted in academia and creates big challenges for ETF providers to describe smart beta in plain English to the end investor. Providers also need to do due diligence of risk factors to ensure that the new ETFs live up to what’s promised, he said.

“Benchmarking and keeping tabs on these managers is a big challenge,” Johnson said, and advisors should look for performance track records and who’s on staff, including portfolio managers, traders and compliance professionals.

“here are great people in this space running some institutional-caliber portfolios, but there are also a lot of yahoos in the space running crazy strategies,” Hougan chimed in. “They’re turning over their portfolios at a rate of 300% to 400% a year. It’s the wild, wild West. These guys are doing interesting things, but you’ve got to be careful.”

Read Morningstar Picks Best ETF Providers for 2013 at ThinkAdvisor.

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