Are active exchange-traded funds just a gimmick? And is there a resolution in sight for any potential further reform of the money market mutual fund industry?
NICSA recently tackled these questions and more with Paul Haaga, former chairman of American Funds, and Bob Pozen, one-time chairman of MFS Investment Management. Moderating the discussion held on the Web was NICSA president Theresa Hamacher.
Hamacher: Let's talk about some of the things that are happening on the product and marketing side (i.e. the blurring of the lines between hedge and mutual funds). How do you see it playing out?
Pozen: You see some long/short funds, but what's interesting is, I actually rarely see a really successful long/short fund. There are a few, but they've never really gathered much assets. The sort of investor who tends of be successful on the long side is a very different person from someone on the short side. It's a very different pace, research group and analysis. I'm sure we'll see more elements of both hedge-fund-type techniques in mutual funds, and more elements of long investing on the hedge fund side. These are different talents, so it may not go that far in attracting a lot of assets.
Hamacher: Where are the lines getting blurred between traditional mutual funds and ETFs? Do you continue to see the same trajectory and growth?
Pozen: The really successful ETFs so far have been essentially index funds. They do provide intraday trading and they're cheap, but so are a lot of index mutual funds. The index mutual funds don't have any redemption fees, so there's a brokerage charge.
So I think it's a pretty close call between index mutual funds and ETFs. For people who are professional traders, the index has to take advantage of intraday trading, but I don't know whether we really want to encourage a lot of individual traders to be intraday traders. And there is more of a risk in the ETF space for some pricing anomalies.
A second question is whether we're going to have actively managed ETFs. So far we have a few but I've never met an equity or an emerging market bond fund manager who's willing to have his or her picks disclosed every day and that's pretty much what you need to do if you want the mechanism of ETFs to work. I could see what I call "quasi-index" or "quasi-active" funds (sort of quant funds where there is a very modest deviation from the index funds) or macro bond funds (where you're really not picking individual bonds and making overall positions).
The third and maybe biggest constraint is we've already run through many topics that are good, like commodities. But I think we reached diminishing returns, and we now see a lot of ETFs that start and don't survive. I think the narrower you get, the more pricing problems you have, and really the less appeal. So I think we'll continue to have some growth in this area, but I'm not sure that the pace is going to keep up.
Haaga: The area I see growth and where I see active management working is in the fixed income area. If we ever get back to high interest rates, I think you would find that bond ETFs would be more attractive and that they could be active, but minimally actively managed.
Hamacher: The debate on money market funds is one that's now been going on for over four years. Does it seem any closer to resolution?
Pozen: It seems a little crazy to be requiring all these new rules on money market funds. I think the credit is obviously good and we ought not to do anything about it.
On the other hand, the area that seems to be the most vulnerable to runs is the large institutional money market funds that invest heavily in commercial paper, sometimes called prime funds. There you do have large shareholders who could move in and out very quickly and you could start a dynamic. They look closely at the NAV and the shadow NAV, and they're very sensitive and ready to move quickly. I would hope that if the SEC did do something, they would confine it to institutional prime funds.
Haaga: You could have a variable NAV and you could still have runs. You could have gatekeeping and still have runs. The regulators have put themselves in a situation where they will have to do something. I think the most likely something is variable NAV, and that they would apply to institutional funds.
Hamacher: What do you think will be the practical implications of all of this?
Haaga: I think if what I suggested happens-variable NAV on institutional only-it would be less attractive because corporate treasurers will want greater assurance of liquidity at a full dollar. I think the other practical outcome is that you will see that, to the extent that there are institutional variable NAV funds, they will have very, very short maturities, very diversified portfolios, and be very liquid including probably a large portion in treasuries.
Pozen: I do think on the retail side, if we went to a fluctuating NAV, it would spook a lot of retail investors. They're comparing these to bank deposits, and with bank deposits they essentially get a stable NAV insured by the Federal Deposit Insurance Corporation as long as they're under $250,000. I think a lot of them would say they just don't want the fluctuation. It's not a big deal for them in the sense of real losses, but on the other hand, it certainly has a lot of appeal. I think over time, the money market industry would lose money to the bank deposits, and the banking industry doesn't have enough capital to support the deposits it has now.