5 Obstacles Facing Active ETFs
Actively managed ETFs have been touted as the ultimate ETF product. So far it has been all hype, or as they say “all show and no go”. With so much buzz, you would think at least one active product would have gained some traction. That is not the case. I haven’t looked at the detailed data yet, but I am willing to make a gentleman’s bet that the two new 3x ETFs launched by ProShares yesterday have already seen more trading action than all of the actively managed ETFs throughout all of recorded history.
Someday, actively managed ETFs may become a significant portion of the ETF marketplace, but for now five obstacles are separating hope from reality:
- Classical/traditional index investors have long used index funds in their asset allocation strategies. This class of investors is migrating to index-based ETFs in order to accomplish the same thing with lower costs and lower tax consequences. Because they don’t believe in active management, they will never purchase an actively managed ETF.
- Many active managers include ETFs along with stocks in their portfolios (this applies to both institutional and retail investors). These investors/managers believe that “they” are responsible for adding the “active” management (alpha) to the portfolio. Therefore, they would rather use indexed (aka passive) ETFs to provide the exposure they desire. For example, if the desire is to overweight the energy sector or small cap value, the manager will choose an ETF covering that niche. Since no one can predict what sectors or styles an actively managed ETF will own next month or the month after that, these investors have no use for actively managed ETFs.
- Day traders and hedge funds use ETFs in much the same way as the investors outlined in obstacle #2 above, except they trade much more frequently, require very high liquidity (both in high volume and very narrow bid/ask spreads), and need transparency in order to fit an ETF into their trading models. These investors will have no interest in actively managed ETFs unless and until they reach the top of the charts in terms of volume, liquidity, and transparency.
- Investors who like actively managed open-end mutual funds typically buy only funds with a three-year or five-year track record that allows them to evaluate the management. Even if the manager is already well-known, they will not simply presume that an ETF version of a familiar mutual fund will deliver the same results. They will want to see an actively managed ETF perform well over a multi-year period before taking the plunge.
- Many successful (in terms of assets under management) actively managed mutual funds have had well-known figures at the helm: Peter Lynch, Bill Miller, Tom Marsico, Mario Gabelli, Don Yacktman, and so on. People who want active management seem more likely to invest with a familiar face, even if the hard numbers are not as attractive as the alternatives. To date, none of the actively managed ETFs have featured a name-brand manager. Once that happens, refer to obstacle #4 above.
Disclosure: no positions in actively managed ETFs