Exchange-traded funds, having broken through the $1 trillion asset threshold, are no longer seen as esoteric products meant just for institutional investors. Rather, they’re on the map as straightforward vehicles that retail investors too can successfully use.
While index ETFs rule the roost with almost 100 percent of all ETF assets under management, actively managed ETFs are nudging for market share.
One of the most interesting differences between the mutual fund market versus ETFs is how investment dollars are being allocated. Today, the bulk of mutual fund assets are invested in active funds whereas most ETF assets are invested in index-linked products. What are the future prospects for actively managed ETFs? And how should advisors be preparing for these changes?
To address such questions, Research spoke with Noah Hamman the founder and CEO of AdvisorShares. The firm as of end-June managed $318 million across six actively managed ETFs.
What are some of the advantages and disadvantages of actively managed ETFs?
By far the biggest benefit is providing professional, discretionary portfolio management, but doing that [with] full transparency, buy and sell control (limit orders), and liquidity. Secondarily, the inherent tax advantages are better than the traditional mutual fund structure. The downside depends on what you are comparing it to, but I might say that most mutual fund investors are not use to dealing with bid-ask spreads and commissions, so incorporating that into understanding the cost of the ETF is important, though that is not unique to just active ETFs.
Active ETFs and active closed-end funds share many of the same attributes. How are they different?
The difference is premium and discounts. Because ETFs are open-ended, authorized participants (institutional who can buy and sell ETF shares in million dollar baskets), have the ability to create new shares or redeem shares at NAV, so if an active ETF were to trade too far from its estimated NAV during the day, [these] authorized participants can arbitrage the price difference, which should have the impact of moving the trading price back to its estimated NAV.
Active ETFs have been lauded for their holdings transparency, but isn’t this actually a disadvantage because of front-running?
Not at all. Front-running is someone [having the] ability to step in front of the trades a portfolio manager is making. I can see that happening to an index, for example during a Russell rebalancing. For an active strategy, you would need to guess what a portfolio manager is doing. In an active ETF, the portfolio manager has all day to make their trades before the new portfolio is shown to the public the next day. I have yet to see any study that transparency causes an active money manager to underperform.
The odds of consistently beating the market are stacked against investors. It’s been proven among various asset classes along with different types of product structures. Do you think active ETFs are the exception?