There have been a lot of “next things” in the mutual-fund industry.
Back in the Internet bubble days, HOLDERs — Holding Company Depository Receipts — were “the next big thing.” After the initial buzz, they fizzled out.
Then it was “folios,” where investors could basically make do-it-yourself mutual-fund portfolios; it was a terrific concept that got almost no traction in the real world.
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What’s next now is a new form of exchange-traded fund that makes it very easy to offer active management built on the framework of an ETF.
The only thing stopping a tidal wave of new issues has been the Securities and Exchange Commission, but there’s a growing sense that the dam will burst soon and that a flood of new active exchange-traded issues will reach the market by year’s end as a result.
But there’s a real question over whether this next big thing will actually be big at all.
To see why — and to decide whether you want to get involved in the new issues or wait for them to prove themselves — you must first get some background.
ETFs are mutual funds built to trade like stocks, trading minute by minute instead of being priced at the end of the day.
Typically, they’re based on indexes, although there are a few actively managed issues like PIMCO Real Return (BOND), as well as active-index and leveraged issues to say that active ETFs already are available.
There is also a suite of ETFs offered by the Vanguard Group that are, effectively, a share class of Vanguard’s traditional funds, but because Vanguard holds a patent on the process for simply creating an ETF share class of an existing fund, the rest of the industry has been unable to follow suit.
ETFs make daily portfolio disclosures — meaning the investor knows what they own — and typically have lower costs.
Portfolio disclosure, however, is a major impediment to the creation of active ETFs because many fund managers don’t want the world to know what’s in their secret sauce.
Then there’s the SEC, because creating an active ETF requires special dispensation from the regulatory agency, which has been tightening up its approvals of late, mostly in the hope of creating a new standard that all fund firms can use.
T. Rowe Price, BlackRock and Vanguard all are pushing their own variations, but the most promising take on this is the ETMF, for “exchange-traded managed fund,” put forward by Navigate Fund Solutions, a subsidiary of Eaton Vance Management.
ETMFs would offer “NAV-based trading,” where the fund trades at its end-of-day net asset value — like a traditional fund — eliminating the need for the daily portfolio disclosure.
While the trade will be executed using the end-of-the-day price, it will occur at a premium or discount to that price that is determined by the market. In short, you could buy an ETF at 10 a.m., with the agreed-upon price being “NAV plus two cents,” meaning your trade will cost you two pennies more than the price of the fund that is determined at the end of the day.
Tough to follow? You bet.
That’s why SEC insiders say it is not the Division of Investment Management — which oversees the fund world — that is delaying active ETFs, so much as the Division of Trading and Markets, which is trying to make sure that they’re not creating a new playground for arbitrageurs, where average investors think they are getting that next big thing, only to find the benefits bled off by sharpies and hacks.
In the end, there should be a ruling on most of the new forms of active ETFs by Thanksgiving, at which point investors will have to decide whether they’re seeing a fabulous bounty or a squawking turkey.
For all of the hype around active ETFs, consider that while exchange-traded funds hold $1.8 trillion in total assets, just $50 billion of that is in active issues.
That paucity of dollars could be because there aren’t many active issues to choose from, or it could be because investors aren’t clamoring for active ETFs at all.
Even with standard ETFs, more than 40 percent of those created have less than $50 million in assets, the point where experts say a fund starts to be worth management’s time to keep it open.
“The SEC would like to put all of the models on the table together and have a little bit of everything rolled into whatever they approve, so that what you wind up with is about 80 percent of each proposal wrapped into one rule that gets approved,” said Tom Lydon, editor of ETF Trends.
“The question is just how much demand there will be for it. You know why the firms are doing it, but you wonder why consumers would buy into it, at least until these issues are proven.”
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at firstname.lastname@example.org or at P.O. Box 70, Cohasset, MA 02025-0070.Copyright 2014, MarketWatch