Active ETFs Picking Up Steam In 2013
Still, I can certainly see some segments within equity that would make sense for active management. I think the emerging and frontier markets space is one such area.
The issue with traditional cap-weighted emerging and frontier markets indexes is that by design, they’re top heavy in many of the same state-owned enterprises—usually from the energy, financial or telecom sectors—that tend to dominate a large swath of a country’s entire market cap.
Moreover, index-based emerging and frontier funds are bound by the country classifications of the index they’re tracking. This means for MSCI-based emerging indexes, it includes South Korea and Taiwan, and carries heavy exposure to the BRICs.
Ruchir Sharma, head of emerging markets at Morgan Stanley, has been saying now for years that the concerted growth within all emerging economies that we saw in the early part of the century may be drawing to a close—or may actually be over, for that matter—and that it’s increasingly making sense to become selective in the emerging landscape.
In a recent interview with IndexUniverse, Jim O’Neill, the “godfather” of the BRICs, agreed, stating that it no longer makes sense to treat all emerging markets as one giant market.
The case for active may be even stronger in the frontier space, where the line between emerging and frontier classification is increasingly becoming muddled, and the dislocations between the development levels between frontier countries is even more extreme.
For example, Qatar and UAE are on the verge of being upgraded to emerging status by MSCI. Should those two countries really be in the same classification with countries like Sri Lanka or Romania?
These dislocations mean for indexes trying to target the frontier space—like the MSCI Frontier Markets Index—that it’s overwhelmingly tilted toward the Middle East.
Taking all this into account, I think Emerging Global Advisors is on to something with the market’s first filing for an actively managed emerging markets ETF. With active management, not only can the manager be selective with specific companies, it’s no longer bound by country classifications based on index providers.
As I mentioned in a previous blog, I think actively managed equity ETFs will eventually blossom when big-time equity managers start launching ETF versions of their flagship mutual funds (like if Mark Mobius decided to launch an ETF version of his Templeton Frontier Markets Fund).
It's inevitable that as assets pour into ETFs, the landscape will continue to evolve. I think active ETFs are only one aspect of the growing industry where we’ll see change.
In fact, the changing active ETF landscape may already be brewing right underneath us.
At the time this article was written, the author held a long position in BOND. Contact Dennis Hudachek at firstname.lastname@example.org.
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