Registered Rep.: Why has there been so much buzz about actively managed ETFs?
Sonya Morris: The ETF market has grown at a torrid pace in recent years, but the vast majority of individual investors' assets (some $9 trillion) are still in mutual funds, most of which are active. The prospect of capturing some of that market share has motivated ETF providers to develop active ETFs. But there are technical hurdles: Because they trade throughout the day, ETFs must reveal their holdings every day to facilitate the creation and redemption of fund shares. This keeps the ETF's price in line with its net asset value (NAV). Active equity managers are reluctant to do that, fearing they will allow rivals to front-run trades that may be in-process. ETF providers have been working on ways to get around this issue.
RR: Are the PowerShares ETFs an attractive alternative to current ETFs and mutual funds?
SM: Based purely on investment philosophy, we're not convinced that these proposed funds bring anything new to the table. Two of the funds will be quantitatively managed. The third equity fund starts with a quant process, but the manager makes the final call about what goes in the portfolio. There are already some high-quality quant funds out there that employ similar tactics, including funds run by Bridgeway, Janus's INTECH team, and Vanguard, so the competition is going to be tough. These new ETFs will have a lot to prove.
RR: Do they maintain the traditional benefits of ETFs: tax efficiency and low cost?
SM: It's too soon to tell. PowerShares hasn't yet revealed the expense ratios on these offerings. As far as tax efficiency goes, we'll have to wait and see. They'll obviously have more turnover than a traditional index fund, which raises the risk of tax consequences. That said, PowerShares Dynamic Market and PowerShares Dynamic OTC have had turnover ratios over 100 percent for 5 years running, and never distributed capital gains. So the ETF structure can handle a certain amount of trading.
RR: What hurdles will future issuers have to get over to make their active ETFs attractive and competitive?
SM: ETFs currently compete on low costs and tax efficiency, and active ETFs must also deliver in that regard. But I think the active ETFs that will fare the best will be those that offer compelling strategies executed by experienced and talented managers. That said, I'm not expecting many active ETFs to meet those standards — at least at first. I think that many good managers will be put off by the transparency issue.