‘Active’ ETFs: A Mixed Bag

mixed-bagOver the last several months, a number of actively-managed ETFs have been launched. These investment vehicles are essentially a hybrid of traditional mutual funds and ETFs, providing many of the benefits that have boosted the ETF industry (lower fees, greater transparency and flexibility, etc.), while implementing an active trading strategy in an attempt to outperform a market benchmark. While truly actively-managed ETFs (i.e., funds that permit managers discretion in trading) are a relatively new innovation, actively-managed ETFs have technically been around for some time, pioneered by PowerShares, which launched several funds in 2008.

Not Quite Active, Not Quite Passive
PowerShares’ actively-managed ETFs are unlike traditional ETFs in that they do not attempt to track any type of benchmark. Rather, the composition of these funds is generally determined by a two-step process: 

Eligible stocks are determined by certain quantitative requirements, such as size (e.g., stocks with a market capitalization of more than $400 million are eligible for inclusion in PQZ). These restrictions effectively limit the potential universe of investments to correspond to popular benchmark indices.
A proprietary stock-screening methodology is implemented to select individual equities.
But these funds are also quite different from traditional actively-managed ETFs with regards to the amount of discretion afforded to managers. Given the strict (i.e., daily) disclosure requirements of ETFs, there exists the potential for traders to engage in “front-running”, or moving into stocks they believe an ETF is in the process of buying and moving out of stocks the ETF is in the process of selling. Although it’s difficult to determine just how effective these strategies are, this “disclosure dilemma” is often cited as a primary reason for the lack of actively-managed ETFs on the market today.

Unlike most actively-managed portfolios that trade based primarily on manager discretion, PowerShares implemented a quantitative methodology, utilizing proprietary models to select stocks it believes will outperform. As such, these funds aren’t fully active either. Initially, PowerShares also placed restrictions on when and how frequently its funds could trade, although these restrictions have since been removed.

Full Story:   http://seekingalpha.com/article/141117-active-etfs-a-mixed-bag

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