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ETFs: Are We Getting the Best They Have?

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In March 2012, when PIMCO launched its Total Return strategy in an ETF, it did so armed with a robust marketing and education budget. The investing world knew PIMCO well, and at that time Bill Gross was anointing the actively managed ETF space as a significant area of opportunity.

During that time, I received calls from journalists asking if PIMCO’s launch would be bad for smaller firms such as AdvisorShares and how it would impact the ETF space. My answer was always the same. First, I was excited to have a firm spend so much money to generate awareness and education around the ETF space, and specifically actively managed ETFs. The size and commitment of an investment from one of the leading managers would benefit anyone associated with actively managed ETFs.

Whenever asked how a firm like AdvisorShares could compete with PIMCO in this area, my answer remained consistent. First, we could not compete with its marketing dollars or number of wholesalers. More importantly, we were not competing with PIMCO’s Total Return ETF at all. Rather we were, and still are, competing with the $15 trillion active mutual fund space.

ETFs represent an enhanced technology with a structure that delivers operational cost and tax efficiencies, and now allows portfolio managers — such as Bill Gross, Jeffrey Gundlach and David Albrycht — to compete on performance, as active managers should. Advisors and investors alike can now easily access active management in both mutual funds and ETFs, and make their investment selections based not on accessibility or marketing dollars, but rather what they determine is the best investment for their portfolios.

The initial question surrounding PIMCO’s Total Return ETF was whether it feared cannibalizing its biggest and most successful mutual fund. It responded with a resounding no: It launched essentially the same investment strategy, with a competitive price and in an ETF structure. With the benefit of hindsight, its decision worked out rather well. The firm raised billions of dollars in the ETF, and its mutual fund assets did not appear to be impacted by the ETF’s presence.

Although not a surprise to those in the ETF space, the strategy’s ETF shares at one time actually slightly outperformed the mutual fund shares. To be fair, it remained unclear how much of that outperformance was ETF structure-related and how much was due to differences in securities used to manage the strategy. Certain regulatory limitations that previously existed on all new ETFs and their use of derivatives were later changed by the Securities and Exchange Commission.

The lesson learned from PIMCO is quite simple: When a well-known firm provides investors with its best strategy or strategies within a more efficient structure, investors will buy it.

PIMCO’s success illustrates why it’s frustrating to witness some of the largest investment management firms known for their active management now coming to market with “smart beta” strategies that are designed to track customized, rules-based indexes. Unlike what PIMCO accomplished, such firms are neither coming to market with their best investment strategies, nor are they representing their historical specializations.

It raises the question of where the benefit is for investors. Such firms, looking to grow their assets under management by chasing certain ETF industry trends, may be disappointed in what seems like a potential lose-lose proposition. While there are probably a variety of reasons for taking this approach, some large investment firms are waiting for the approval of non-transparent ETFs. Regardless, not putting your best product — whether passively managed or actively managed — into the best investment structure is not a good recipe for success or for prospective ETF investors.

— Check out “Bitten but Not Mauled, Low-Volatility ETFs Attract Fans” on ThinkAdvisor.


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