Firms Launching Actively Managed ETFs, But Advisors Are Unlikely To Use

Thursday, August 16, 2012 15:38
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Firms Launching Actively Managed ETFs, But Advisors Are Unlikely To Use

Tags: active management | ETFs | index investing | mutual funds | passive investing

Money management firms are increasingly starting to launch actively managed ETFs.

In recent weeks, BlackRock, Fidelity Investments, PIMCO, and John Hancock have launched or plan to launch actively managed ETFs. See my MarketWatch column on the subject.

But those firms will have to work hard to convince advisors to use these funds which are presumed to offer low-cost, intra-day trading, and a chance to beat the indexes. Indeed, not one advisor who responded to my informal survey uses or plans to use actively managed ETFs with their client’s portfolios.

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The reasons vary. For instance, some advisors don’t see any advantages to adding either actively managed fund ETFs or mutual funds for that matter to their clients’ portfolios.

Larry Luxenberg, a portfolio manager with Lexington Avenue Capital Management, says his firm doesn’t use actively managed funds be they ETFs or open-ended mutual funds. “Academic research consistently shows that index or passive vehicles outperform the majority of actively managed funds while lowering risk,” says Luxenberg. “That has been borne out by experience over the last few decades. While an ETF might be a more tax-efficient vehicle, the underlying investment results don’t change from switching vehicles.”

Other advisors, including Karl Frank CFP, MA, MBA, MSF, president of A&I Financial Services, say there are no actively managed ETFs that are better than what is currently available with other products. “Our investments due diligence process hasn't turned up an active ETF that we like better than the traditional mutual funds we recommend,” says Frank. “To make a change, we also have to look at the tax implications for selling and buying.”

Another advisor prefers using passive investments to actively managed investments. “I do not use actively managed ETFs,” says Robin Tan, Ph.D., CFP with KMS Financial Services. “I prefer index-based ETFs due to lower expense ratios. For active funds I still prefer mutual funds at this time due to better historical data.”

And still other advisors don’t use actively managed ETFs in part because the tracking errors are too great to consider. Thomas E Murphy, CFP, a registered principal and partner with Murphy & Sylvest, offers this tale:

“We started using ETFs in 1996 and had great success with them until about 2005. At that point ETF investing had become so popular that they began to stop working well. This means the tracking error to their respective indices became unacceptably wide. 2007, 2008 and 2009 showed huge daily tracking errors which created significant cognitive dissonance for clients. (What they read in the paper did not match their investment performance.)

“Consequently, we moved away from ETF investing back to the more traditional purchasing of individual stock and bond positions. We continue to use certain country specific ETFs in areas where individual issue purchases would be problematic.

 “Our review of actively managed ETFs is that their tracking errors are even larger than passive ETFs. They are also often thinly traded, sometimes very thinly traded which runs the risk of “moving the market” if we purchase large positions. The tax advantage of active ETF investing is not enough to overcome their additional costs given these tracking and trading issues leaving passive index mutual fund investing as superior for smaller accounts and individual positions superior for larger accounts.”

And still others are taking a wait-and-see approach given the newness of the product. “While we’re monitoring the performance of actively managed ETFs, we don’t currently use any in our clients’ portfolios,” says Dan Forbes, CFP of Forbes Financial Planning. “The strategy is relatively new. We like our investments to have a proven track record in terms of performance and transparency before incorporating them into our portfolio mix. We do agree that the mixture of tax efficiency and low expense make them worth considering, and it’s possible that we’ll use them in the future.”

 Other advisors, meanwhile, say they would use an actively managed ETF if it proves to be the best product for the client. “We’re agnostic in this office on the form in which we own client investments (open-ended or closed-end mutual fund, actively managed or indexed ETFs, and the like),” says Tim Knotts, CFP, of the Hogan-Knotts Financial Group. “We want the best (as determined by a set number of filters/benchmarks) managed accounts we can find for our clients.”

Bottom line: It would appear firms that want to get advisors to use actively managed ETFs in their client’s portfolio have a very, very long row to hoe.

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