Actively Managed ETFs: Slow to Grow, But Building Momentum

The hot topic in the media right now is actively managed exchange-traded funds. But given how relatively small the actively-managed ETF universe is compared to the overall ETF universe, this product has received an outsized amount of attention.

The good news for investors is that this category of ETF is likely to grow further and is showing some momentum, said Tom Graves, an equity analyst at Standard & Poor’s, in a phone conversation.

At the recent Morningstar 2010 Investment Conference, which took place in Chicago June 23 through June 25, Grail Advisors announced it formed a strategic relationship with DoubleLine Capital and has filed a registration for an actively-managed ETF-the Grail DoubleLine Emerging Markets Fixed Income ETF.

“The marketplace for actively-managed ETFs didn’t exist until May of last year with the launch of the Grail American Beacon ETF,” William Thomas, CEO of Grail Advisors, the San Francisco money manager, said in an interview at the Morningstar conference.

In January, Grail announced it launched the Grail McDonnell Intermediate Municipal Bond ETF and the Grail McDonnell Core Taxable Bond ETF. Both of the bond funds are actively managed and subadvised by McDonnell Investment Management LLC, a Chicago-based fixed-income specialist that manages more than $13 billion in assets.

Graves pointed out though that there are a few things standing in the way of more growth in the actively managed ETF arena. One of the advantages of traditional ETFs is transparency so investors know where their money is going. But some fund managers, he said, are reluctant to disclose their buying and selling on a daily basis because they don’t want to have other investors or money managers follow their investments and drive the price up. This has limited the number of actively managed ETFs available on the market.

Another thing holding back the growth of actively managed ETFs is the absence of more of a track record, said Graves. Unlike mutual funds, actively managed ETFs debuted in 2008 so they don’t have multiple years of performance. “My sense is as we get more history and more performance it will attract money to them,” Graves said. “Right now the biggest of the actively managed ETFs are in currency and fixed income and not in equities.”

In the last year PIMCO introduced three actively managed ETFs, including its Enhanced Short Maturity Strategy Fund (MINT) that primarily invests in short duration investment grade debt securities. Since it launched MINT in November, it has attracted $660 million in assets, said Graves.

Currently, three companies—BlackRock Inc. [BLK], State Street Corp. [STT], and Vanguard Group—dominate the ETF market. In December, BlackRock Inc. completed its $13.5B acquisition of Barclays [BCS]—a longtime leading ETF provider with its iShares products—to become the largest provider of ETFs in the industry. BlackRock’s ETF business increased 44.5% to $114.7 billion last year, and already this year, BlackRock has started to introduce new ETFs. As of June 30, the Big Three companies had about 83% of ETF assets.

Last year, nine companies began offering ETFs as the total number of funds increased by 10%. Three of those nine companies, including Grail Advisors, introduced actively managed ETFs. WisdomTree has eight actively managed ETFs, which are all currency related, with $1.2 billion in assets, said Graves.
So far no equity ETFs have made a big splash in terms of gathering assets. But Graves sees more opportunities down the road for a big mutual fund manager, a sell-side brokerage firm, or a company like Vanguard, which has the infrastructure in place to utilize their resources toward actively managed ETFs.

Already money managers are seeing assets move into ETFs and move away from mutual funds because of the advantages of ETFs, such as interday trading, transparency of holdings, and in some cases low cost structure. Graves believes that if money managers and brokerage firms want to be able to hold on to, or grow, their assets they will need to get more prominent in the ETF arena. Or else run the risk of losing clients’ money to competitors. Some companies, like Charles Schwab, have already cut commissions to compete on price. Others, like PIMCO, have differentiated themselves by offering actively managed ETFs.

“My sense is that the ETF market is an evolving environment,” said Graves. “We’re not only going to see the debut of new ETFs or the closing of existing ones that don’t have sufficient assets, but we’ll also see some merge together.”