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June 20, 2014 at 11:42 PM
The splash ETFs made when they hit the market in the 1990s displaced a lot of mutual fund market share.
That is because investors have voted with their dollars for exchange-traded funds’ tax-efficient structure, lower cost, transparency and tradability.
Two decades into the ETF era, actively managed mutual funds, which made up 95% of the market in 1998, now total just 76% of the fund market, with ETFs now neck and neck with passively managed mutual funds, each holding a 12% market share, according to the Wall Street Journal.
Attempts to combine the advantages of active stock selection with ETFs’ favorable structure continue apace through actively managed ETFs.
But progress has been slow, with active ETFs amounting to little more than 5% of assets since the first active ETF launched five years ago.
A key reason for the languid pace? ETFs’ vaunted transparency.
Top active managers want to shield their portfolio decision-making from copycats, something hard to do with ETFs, which reveal trades daily, unlike mutual funds, which need not disclose their holdings more than once a quarter.
A potential breakthrough may be at hand, however, as a small startup with a big backer — Navigate Fund Solutions, a wholly owned subsidiary of Eaton Vance — is shepherding what it calls exchange-traded managed funds (ETMFs) through the SEC approval process.
“This is a way to deliver active strategies with better performance and improved tax efficiency,” says Stephen Clarke in an interview with ThinkAdvisor.
Clarke is trolling the halls of the Morningstar Investment Conference to make the case that a better mousetrap exists for investors who prefer actively managed funds.
If Clarke can convince the Securities and Exchange Commission, financial advisors and retail investors of ETMFs’ virtues, then the fund market may once again take on a different shape as it did with the advent of ETFs.
The reason for ETMFs’ “better performance,” according to Clarke, is that “the horse is carrying a lighter jockey.”
The portfolio depends entirely on the manager’s investment selection, but “if you put the same portfolio in a mutual fund and an ETMF, the ETMF ought to outperform the mutual fund based on its lower operating costs and improved trading efficiency,” Clarke says.
What would this mean to advisors who prefer actively managed mutual funds?
“I would estimate a difference of 50 basis points of annual performance improvement,” Clarke says. The Navigate president is not looking to compete with ETFs, which would remain cheaper than ETMFs. Rather, ETMFs are meant to lower the cost of mutual funds and facilitate active management, which remains the dominant approach in the investment marketplace.
So a standard advisor-sold mutual fund whose expenses average 120 basis points, but which could go as high as 220 basis points depending on share class, could see its cost shrink to 70 basis points.
That’s still higher than the estimated 20 basis points of a similar ETF, but, again, ETMFs are meant to compete with existing mutual funds.
The cost advantage stems from applying aspects of the ETF structure while — in contrast to active ETFs — retaining the mutual fund’s portfolio confidentiality.
By using the same trade settlement structure as ETFs, ETMFs reduce transfer agency costs from an average of 19 basis points in a mutual fund to less than a basis point in the exchange-traded format.
