Grail’s Active Strategies: A Deeper Look

October 21, 2009

In the increasingly crowded exchange-traded product arena, what does 'actively managed' really mean?


As the exchange-traded product arena has become increasingly crowded, issuers have become more inclined lately to label new ETFs as “actively managed” in order to differentiate themselves from the pack. The challenge becomes sussing out what "active" really means.

For all the marketing spin, Grail Advisors’ four recently launched single manager RiverPark ETFs seem to fit the definition. Let's dig in.

The new RiverPark funds are mostly invested in companies listed in the S&P 500 Index, and have four separate focuses: RiverPark Technology ETF (NYSEArca: RPQ), RiverPark Financials ETF (NYSEArca: RFF), RiverPark Growth ETF (NYSEArca: RPX) and RiverPark Focused Large Cap Growth ETF (NYSEArca: RWG). We covered the initial launch of the four funds here.

While there are competing ETFs in this space, so far they have tended to be overseen by multiple portfolio managers and/or have tight quantitative strategies that limit the role of true active management. For example, the PowerShares Active Alpha MultiCap Fund (NYSEArca: PQZ) alters its holdings on a weekly basis, and does so using a proprietary quantitative model that picks stocks based on factors such as earnings growth, investment inflows and relative valuation.

The Grail funds (for better or worse) are different, and use a more traditional active management process, where one manager makes all the investment decisions based on their own investment criteria (confined to broad individual company and sector weighting parameters). That distinction accounts for a completely different investment vehicle to the quantitative funds, in effect making the new ETFs tradable, tax-efficient mutual funds with a 0.89 percent fee.

“We are the polar opposite of an index fund,” Morty Schaja, chief executive of RiverPark Advisors, told in an interview. “We are marrying a conservative view of valuation with an aggressive view of the fundamentals: We’re more likely to invest when the price is down, and take money off the table after the price appreciates.”

Under The Hood ...

A quick glance at the funds’ holdings proves the point. Take RWG, the large-cap growth ETF, as an example. Compared with its quant rival, the PowerShares Active MegaCap ETF (NYSEArca: PMA), RWG looks like a purposely contrarian investment.

PMA’s top 10 holdings comprise 50 percent of the fund’s assets under management: Seven of those companies are among the top 40 weightings of the S&P 500. By comparison, just five companies of RWG’s entire 23 holdings are among the top 40 weightings in the S&P 500 (Apple, PepsiCo, Google, Goldman Sachs and Qualcomm). Some RWG holdings look especially off-the-beaten-path: EMC Corp., a $36 billion IT giant with 70 percent in gains year-to-date, doesn’t even feature in the S&P 500 Index, clearly an active call.

For the most part, however, RWG’s holdings paint a clear picture of the ETF’s unusual blend of value-oriented and growth strategies. For example, obscure holdings such as Gilead Sciences, Varian Medical Systems and Monsanto, which all have price-to-earnings ratios in their teens, form a chunky 13 percent of the fund. But RWG still manages an overall higher-priced (relative to earnings) range of companies among its top 10 holdings than PMA.

Theoretically, RWG’s single-manager strategy should allow the manager to weed out the bad apples and pick the ripe ones?that’s the whole point of active management, after all. It’s worth pointing out that the tale of history is not on Grail’s side. As we consistently document here?as a class?active equity managers have a poor track record of recouping their expenses, much less generating alpha, only very occasionally eking out a win vs. their passive peers.

One additional concern with any active strategy is the “dry powder” syndrome. Right now, RWA is sitting on 7 percent in cash. While this can serve as a huge advantage in certain market conditions, conventional index investors may be perturbed by paying a management fee for cash positions. Still, RiverPark’s Schaja points out that this is an unusual event, and that the fund intends to keep no more than 2 to 5 percent of its assets in greenbacks.


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