Fund Managers Love Active ETFs, But What's Their Role In An Actual Portfolio?

Tuesday, March 13, 2012 08:49
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Fund Managers Love Active ETFs, But What's Their Role In An Actual Portfolio?

Tags: ETFs

Some investment products become wildly popular with their sponsors and managers, but are a tougher sell to the actual investors. Active ETFs may be the perfect illustration.

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Charles Schwab has jumped into the active ETF arena in an effort to carve out a role for itself as a seller of non-indexed exchange-traded funds.

 

It's likely that the first actively ETFs out of the Schwab pipeline will be clones of its existing mutual funds, much like PIMCO's recent effort to duplicate its Total Return fund in ETF form.

 

Fund complex executives love active ETFs as a new way to monetize their existing fund management and marketing expertise.

 

On paper, it's a brilliant idea. After all, growth in the mutual fund world has slowed down, so why not spin out the portfolios into an asset class that is cannibalizing market share from those older products?

 

However, the PIMCO move has so far won scattered yawns and about $100 million in asset flows, which is not bad for a barely a week of active subscriptions but is still sub-average for the active ETF market.

 

And active ETFs themselves represent a tiny niche in the almost exclusively indexed ETF world.

 

Commission-based advisors won't recommend ETFs of any type because they can't get paid on those assets.

 

Fee-based advisors would generally rather build a portfolio out of lower-cost passive funds, maybe with some favorite active managers in the mix.

 

Institutions have their own money managers -- or should -- and so tend to use passive ETFs as core beta holdings to round out their proprietary strategies. Active ETFs would get in their way.

 

That leaves self-directed investors as the target market here. While there are rumblings that the self-directed investor is back, it's unclear whether these people are diving back into actively managed mutual funds the way they once did.

 

The cult of the active fund manager seems to have died a messy death over a decade ago and never came back.

 

Unless active ETFs can somehow rebuild that mystique -- with or without the traditional funds by their side -- they probably won't get much traction.

 

Look at the wasteland that indexed ETFs have become. Outside a few hit funds, there aren't many of these vehicles that crack $100 million in assets. 

 

Many launch to some hoopla as a novelty, then stall at under $12 million or so. At these levels, it's hard to trade these things actively even if someone wanted to do so -- and if it doesn't trade, why not just buy a mutual fund instead?

 

Still, the ETF complexes love launching these things like balloons. They'll keep launching them until they run out of money. 

 

Last point: it's more expensive to run an active fund. That's why the fees are higher. PIMCO is subsidizing its overhead because it's already paying the managers on the mutual fund side.

 

But an active ETF with no preexisting mutual fund to support it could have a much harder time.

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