The Nontransparent ETF Wild Card
So what's next for actively managed ETFs? That's hard to tell. Clearly, there are pockets of the market—such as fixed income—where these strategies have found a following, and managers are succeeding in delivering on their ideas.
But there's a good chance active equity ETFs might never really get off the ground. Instead, they could find serious competition in the upcoming nontransparent ETF-like structure Eaton Vance has in the works. The ETMFs that Eaton Vance will simply market as NextShares could be the answer alpha-seekers have been looking for in an ETF wrapper.
The structure offers all the benefits of the active ETF wrapper, but without daily transparency.
If traction is any sign of success, here's a clue: There are already 11 companies signed up to offer ETMFs when they come to market—firms such as American Beacon, Hartford Funds, Victory Capital, Pioneer and Gamco Investors.
It's noteworthy to see people like Gabelli jump on the bandwagon, because until now he has professed himself a nonbeliever in the ETF structure.
"I never really liked the notion of ETFs," said Gabelli, whose firm manages some $45 billion in assets. "They are basically buying a basket of stocks, and we saw what happened in 1999—they kept buying Cisco because it was weighted in the index. That didn't go well."
Market-cap weighting in equity ETFs is only one of the things he dislikes about them. Their passive, replicate-the-index approach is another. If you own a passive U.S. equity fund and the market is going down, you too are going down with it whether you like it or not.
"We would always have this debate with John Bogle about what happens in a down market: Would you ever be able to be up in an ETF? The answer is obviously no," he said.
Research Is Crucial
As a stock picker whose firm's core competency is research, Gabelli argues that accepting the market ride isn't enough, and there are "good bargains" to be found by active managers. But these bargains are best captured when the whole world doesn't have to hear about them. Transparency in the ETF wrapper is another issue.
"We don't want to share our ideas of the world while we're just starting to buy them," Gabelli said. In a mutual fund, portfolio managers can keep their buying and selling quiet until the next round of 13F filings requires them to disclose them. The SEC requires 13F forms be filed within 45 days of the end of a calendar quarter.
Gabelli's convictions are in stark contrast to those of people like Burton Malkiel, Eugene Fama, John Bogle, William Sharpe and a long list of luminaries who believe in extracting value in a passive way. There are plenty of doubters about the whole idea of active ETFs and of ETMFs.
"There is still a lot of work to be done on building the infrastructure for ETMFs," ValMark's McClary said. "I think it's still somewhat unclear whether the players involved are willing to accept that ETMFs are the next Netflix or YouTube, instead of the next LaserDisc."
"I have to think that we will have a better mousetrap to provide liquid active management than the ETMF structure sometime in the next five to 10 years," he added. "Size is the chicken-or-egg problem in the traded investment product business. I think it will take a lot of faith on the side of the investment managers who become the first big buyers of ETMFs."
Changing Business Models
But Eaton Vance, mindful of this vast appetite for outperformance, is hoping NextShares could be the answer for managers like Gabelli who know that lower-cost investing is the future.
"You have to be aware that business models change," Gabelli said.
He would know. The first 39 years of his firm involved a lot of reinvention, going from research for commission dollars, to money management, to hedge funds in the early 1980s, to mutual funds in the mid-80s.
"We are always thinking about how the structure of the way we manage money is changing," he said. "What drove us to nontransparent ETFs is the notion that in the next 39 years of our firm, things are going to change, and this is a change that will work. It's good for the customer in the sense that it's lower cost, and it has tax benefits that traditional mutual funds don't."
Are ETMFs the future? Maybe. Maybe not. But they certainly hold the promise to bring large mutual fund managers to the ETF market doorstep.
"I'm not going to join in the evangelical movement to see what the next step for ETFs is going to be," Gabelli said. "But from a very practical business guy's point of view, with a comparative advantage of also being an investor, at the moment there's an inherent flaw with the mutual fund structure with regard to tax structure. There's an inherent advantage with ETFs in the transfer fee. This is a logical step for us."