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Active ETFs Wait for Their Heyday

They offer investors low costs and transparency, but even after the ballyhooed launch of PIMCO Total Return, they remain a tiny part of the ETF universe.

Ben Johnson, 10/15/2013

This article originally appeared in the October/November 2013 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.  

As a fan of the Chicago Cubs, I am all too familiar with the spring mantra: “This is our year.” So, as someone who is also charged with analyzing the exchange-tradedfunds industry, I wince when I hear talk of the “year of the active ETF.” Each of at least the past three years has been heralded as such by the financial media and industry watchers (including Morningstar). But there is no doubt that the active-ETF space has been long smoke and short fire with a few notable exceptions. I’ve examined the current crop of actively managed ETFs and highlight the characteristics that are hallmarks of a fund worthy of your investment.

The Appeal
It’s easy to see why we all have become a little enamored with the potential of these vehicles. Active ETFs give investors an efficient way to gain access to active investing strategies that is cheaper, more transparent than open-end mutual funds. They’re also very tradable.

But brand-name managers, aside from PIMCO, have been slow to climb aboard the supposed bandwagon. Managers who run concentrated portfolios, for example, are not keen to show their portfolios on a daily basis, which is a feature of ETFs. Also, some managers are reluctant to operate in a vessel with no loads or redemption fees to buffer the costs associated with asset flows.

Despite these concerns, firms are preparing to take the plunge. There are far more firms that have filed to launch active ETFs (35) than there are current providers of such funds (15) at the moment. Most of them are fixed-income funds, and many of these are of the very short-term variety. Because bonds are traded over the counter instead of on an exchange, fixedincome managers are less concerned with other investors front-running or shadowing their portfolios. Daily transparency is not much of a concern for them.

A Drop in the Bucket
Bear Stearns launched the first actively managed ETF in 2008. Called Bear Stearns Current Yield, it quickly closed that same year as the parent firm collapsed. Five years later, actively managed ETFs are still struggling to gain traction. As of August, there were 64 actively managed ETFs holding $14.4 billion in assets. That take represented a measly 1% of the total assets invested in exchange-traded products. Even more telling: 60% of actively managed ETF assets are in funds run by PIMCO. Indeed, PIMCO Total Return BOND alone accounts for about 30% of all active ETF assets.

Fund companies such as PIMCO have effectively used the ETF wrapper as a new means of distribution to deliver time-tested active strategies to the masses in a manner that reduces the cost of investing in them for a wide swath of investors. That’s not always the case, though. Others such as AdvisorShares Global Echo GIVE seem keen to leverage the category as a way to market funds with unproven managers that wouldn’t likely stand a chance in a traditional mutual fund format. Then, there are funds in the category that aren’t really actively managed at all. For example, the WisdomTree Chinese Yuan ETF CYB is a single-currency fund that is classified by the Securities and Exchange Commission as an actively managed ETF largely on the basis of a technicality—it doesn’t track an index.

Bigger, Cheaper Are (Generally) Better
The good news for investors is that it is very easy to discern among the good, the bad, and the “other” in the actively managed ETF universe.

Ben Johnson is Morningstar’s Director of European ETF Research.

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