During the late 1980s, “The Future’s So Bright I Gotta Were Shades” soared to become a hit pop song for its optimistic outlook. A similar tone has overtaken product developers who are banking on the bright future of actively managed ETFs. Will active ETFs overtake traditional mutual funds?
It’s been 16 years since the first ETF, the SPDRs Trust (SPY), was introduced on U.S. stock exchanges. And from the start, few could have accurately predicted the success of ETFs. They began as obscure trading instruments resembling closed-end funds, but with lower expenses, greater tax efficiency and no significant premiums or discounts to net asset value. Institutional money managers were quick to appreciate the benefits of ETFs and, in time, the investing public then followed.
Today, the bulk of ETF money is invested in funds that follow traditional indexes. Of the 744 U.S.-listed ETFs, just 15 funds use full-blown active strategies attempting to beat the market. Some see active management as a source of future growth.
While ETF assets are rapidly growing, they’re still tiny compared to mutual funds. According to the Investment Company Institute, there’s currently $9.69 trillion invested in mutual funds whereas just $540 billion in ETFs. Mutual funds have been able to hold their dominant position mainly because of their stronghold in 401(k), 403(b) and 457 retirement plans.
Active ETF Origins
The very first actively managed ETF was nothing short of a flop. The Bear Stearns Currency Yield Fund (YYY) debuted in March 2008 and within months of being introduced the fund was liquidated. The stigma associated with financially troubled Bear Stearns, along with turmoil in the financial markets, was too much for YYY to overcome. It wasn’t a good start.
Weeks after the first active ETF was born, InvescoPowerShares launched the PowerShares Active Alpha Multi-Cap Fund (PQZ) and PowerShares Active AlphaQ Fund (PQY). Over the past year, both funds have not kept up with their peer benchmarks. For the one-year period ending May 30th, PQZ fell 46.64 percent compared to a 32.39 percent decline in the Dow Jones U.S. Total Stock Market (TMW). PQY has declined by 32.43 percent while the Nasdaq-100 (QQQQ) declined 29.01 percent. And PowerShares says its Active Mega Cap Fund (PMA) has outperformed its benchmark, the Vanguard Mega Cap 300 (MGC), by about 6 percent since its inception in April 2008.
A number of ETF providers have indicated plans to offer funds with active strategies. According to the SEC filings, Claymore Securities is planning three actively managed ETFs, one of which will be modeled after selections made by top economist Art Laffer. The other proposed funds are the Claymore/S&P Commodity Trends Strategy ETF and the Claymore Active National Municipal ETF. Claymore currently manages 45 ETFs with around $1.4 billion in assets.
The Claymore Laffer MacroEconomic Global Equity ETF will be launched as a fund of funds, investing in a mixture of various ETFs. The fund will select ETF investments using global economic factors and proprietary research.
Grail Advisors, a San Francisco-based money manager, has also been aggressively pursuing the active ETF marketplace. In May, the firm launched the Grail American Beacon Large Cap Value ETF (GVT). The fund holds 122 stocks, with Microsoft, Royal Dutch Shell and Chevron representing the top three holdings. Brandywine Global Investment Management, Hotchkis and Wiley Capital Management and Metropolitan West Capital Management share responsibilities in managing the fund. GVT’s annual expense ratio is currently 0.79 percent.