When, If Ever, Will Active ETFs Take Off?

July 07, 2015

[This article originally appeared in our July issue of ETF Report.]

It's been seven years since the first actively managed ETF came to market, and 127 or so funds later, there's still little to suggest that active management in ETFs is going to get much traction, particularly in the equity space.

Out of $2 trillion-plus in U.S.-listed ETF assets today, less than 1 percent is tied to actively managed funds. The asset-gathering success stories are almost exclusively in income-generating investments such as the PIMCO Total Return (BOND | C) that Bill Gross launched in 2012, which has $2.6 billion in assets under management, or funds tapping into master limited partnerships. There are plenty of active ETFs dwindling on the vine.

Active ETF Hurdles
These funds face several challenges. For starters, actively managed ETFs by design are expected to deliver outperformance, but they often underperform their benchmarks, particularly in bull markets such as the one we've been in for several years now.

Price is another problem. These funds aren't necessarily cheap to own, and we live in a world of downward pressure on cost. They are also fully transparent, unlike the mutual funds they compete against, and that's something that has kept many money managers away from active ETFs. In the world of alpha generation, protecting the secret sauce is a way of life, but the current active ETF wrapper requires daily transparency.

Still, there are plenty of ETF fans out there who want to outperform the market. These investors are finding other ways of meeting that need. The proliferation and increasing adoption of smart-beta ETFs is one of them.

Many would argue smart-beta funds are just another flavor of active management, even if they're primarily passive ETFs. Their appeal relative to active ETFs is simple: Advisors are now the ones "actively" combining these passive wrappers in search of outperformance without needing to worry about active management at a fund level.

There's also a new structure coming to market that may offer a compromise between active ETFs and mutual funds, finally bridging the two worlds with an ETF-like wrapper. Eaton Vance's exchange-traded managed fund (ETMF), which will be marketed as NextShares, already has the likes of Mario Gabelli—head of Gamco and someone who's never touched ETFs before—behind it.

Smart Beta Winning Big
The appeal of smart-beta funds with alpha-seekers is undeniable. These funds essentially use different factors or tilts that historically have been reserved for bona-fide active management, allowing investors the ability to hone in on where they believe opportunities are.

So far this year, 34 new smart-beta ETFs have come to market, or about one out of every three new ETF launches. Of that total, 29 of them are in the equity space—the same asset class where actively managed ETFs seem to struggle the most.

Perhaps more impressive is the amount of assets investors have poured into this space—roughly $40 billion as of the end of May, according to FactSet data. This universe already comprises more than 450 different strategies, where the biggest one has a whopping $29.7 billion in assets. That's traction.

Bull Market & Cost Hurdles
Eric Shirbini, global product specialist with Edhec Risk Institute, is quick to point out that the smart-beta trend is still in its infancy, so it's too soon to pin the unimpressive growth of actively managed ETFs on the impressive rise of smart-beta funds. The problem, he says, hinges on performance—or lack thereof.


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