With actively-managed ETFs still being a relatively new product, providers are trying hard to garner investor interest through many different means. One of those is by lowering the expense ratio of the Active ETFs temporarily through fee waivers. Fee waivers are common in newly launched actively-managed ETFs where the ETF manager provides a reimbursement of some portion of the gross expense ratio, for a contractually set period of time, in order to make the product more competitive. The hope is that the “discount” would help attract investors up front into the fund. However, what’s important to note for investors is that those fee waivers can be removed at the discretion of the issuer once the contractual period – which is usually about 1 year from launch – expires.
Where to find disclosures on fee waivers?
The above snapshot from a prospectus is what the typical expense disclosure section looks like for an actively-managed ETF. As you see in this case, the total annual fund operating expenses, or what may also sometimes be called the “Gross Operating Expenses”, are 1.27%. That figure includes the management fee for the advisor and any operational fees that would be a part of “Other Expenses”. Below the total expenses line, you see a line for “Less Reimbursement” and that is what represents the fee waiver provided by the advisor, if there is one. In this one, there is a fee waiver of 0.02%, which effectively reduces the “Net Operating Expenses” to 1.25%.
The more important point to note is the disclosure that accompanies any fee waiver, in this case in disclosure (b). The disclosure provides details on the fee waiver. As indicated, the fee waiver is contractually agreed upon to keep the net expenses under a certain limit. The key piece of information to take note of here is the end of the contractual period for the fee waiver – in this case May 6, 2011. That represents the date on which the advisor may either renew the fee waiver for an additional period of time or let it expire. Letting the fee waiver expire would mean that the ETF’s expenses would rise to the “Gross Operating Expenses”. As such, if investors are not aware of the pending review of the fee waiver, they might well see their expenses rise and be in for a surprise.
Which Active ETFs currently involve fee waivers?
If you go to our Active ETFs Database , all the Active ETFs that have a “*” next to their expense ratios are the funds that have fee waivers in place and the expense ratio shown shows the net expenses after the fee waiver.
At the moment, there are 3 primary issuers who have utilized fee waivers as a means to attract investors to their products – Grail Advisors, AdvisorShares and PIMCO.
Grail Advisors has fee waivers in place on all of its existing actively-managed ETFs. The first thing you notice in the table above is the huge fee waiver on the Grail American Beacon Large Cap Value (NYSE:GVT) of 11.31%. The gross expenses on GVT listed in its latest prospectus are a massive 12.10%. After speaking to the guys at Grail Advisors, I was told that the initial gross expenses of 0.85% listed in the first prospectus, were based on estimates of an asset base that ended up being too high, hence the cost of maintaining the ETF trust as a percentage of assets is higher. Another explanation is that at the time of issuance of the latest prospectus, GVT was the only fund in the trust and hence the base costs that should now be allocated across Grail’s five funds were all borne by GVT. But at the end of it all, investors still pay 0.79% net, after the fee waiver which was increased to maintain the same net expense ratio promised to investors.
Another thing that stands out is the “0.00%” waivers on RWG and RPX. For these funds, there is no reduction in the gross expenses, which are 0.89%. But if for some reason in the future, the operating expenses were to rise, then the advisor would be obliged to keep expense ratio at 0.89% by waiving any additional expenses. As such, in this case, the contractual agreement is more of a “cap” on the fund expenses rather than an outright discount to investors.
How Grail Advisors has reacted at the end of the contractual period can provide some indications of their plans. So far, 3 of their funds have reached their initial contractual expiry dates – GVT (April 30, 2010), (NYSE:RWG) (August 31, 2010) and (NYSE:RPX) (August 31, 2010). The dates in the brackets were the expiries on the initial contractual agreement for fee waivers put in place at fund inception. On each of those dates, Grail Advisors chose to extend the fee waivers until February 28, 2011. One reason for this would be that none of those funds have had much success in garnering assets, so removing the fee waiver and increasing expenses would reduce chances of that even more. Likewise, (NYSE:GMTB) and (NYSE:GMMB) have also not see much investor interest, so I would bet on their fee waivers being extended at the end of their initial contractual periods.
The Active ETFs listed above are the ones from AdvisorShares that have contractually agreed upon fee waivers in place. AdvisorShares’ oldest fund, the Dent Tactical ETF (NYSE:DENT), does not have any fee waivers.
Neither of the two funds above has reached their initial expiry dates because they were only launched in July 2010. AADR has a fee waiver of 0.02% while GRV’s fee waiver acts more as a cap on the expense ratio, rather than a discount on the expenses.
All 3 of PIMCO’s actively-managed ETFs have fee waivers that bring their expenses down to 0.35% across the board. That results in the Short Term Municipal Bond Fund (NYSE:SMMU) having the largest fee waiver of all 3 at 0.20%.
Each of the fund’s fee waiver agreement is valid until October 31, 2011. That actually makes these funds an exception because the length of the agreement is almost 2 years, compared to around 1 year for most other Active ETFs. Given that PIMCO’s Active ETFs have been a lot more successful, especially (NYSE:MINT), than funds from other providers, PIMCO might be more likely to allow the fee waivers to expire since they’ve done their job – help gather assets into the new funds.
While the fee waivers no doubt are a benefit to investors, investors have to be wary of what’s to come once the contractual agreement providing those fee waivers expires. Most actively-managed ETFs that have not had much success attracting assets are likely to extend the fee waivers, as Grail Advisors have done, but others may not, resulting in higher expenses than before.
In general, a good guideline when going about choosing Active ETFs to invest in, would be to ask yourself if you would still be investing in the fund if there was no fee waiver to reduce the gross operating expenses. If no, then you would definitely want to keep an eye out on how the advisor reacts once the fee waiver agreement expires.
Shishir Nigam is the founder of ActiveETFs | InFocus (http://www.etfshub.com/), which provides extensive coverage and analysis of actively-managed ETFs in US and Canada, including debates on major industry trends, insights on the latest product launches from issuers in the Active ETF space as well as in-depth interviews with industry executives and thought leaders.
Disclosure: No positions in above-mentioned names.
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