Are Actively-Managed ETFs Right for You?

In just a few years, exchange-traded funds have acquired $590 billion in assets by relying on a low-fee passive strategy of tracking an index of securities. But the ETF industry is still hungry for more assets. In order to get a piece of the $10 trillion open-ended mutual fund market, some ETF providers are unveiling a whole new lineup of actively-managed products that will be run by portfolio managers.

The second such fund, the Dent Tactical ETF, is expected to launch in two weeks while a string of ETF heavyweights, including State Street Global Advisors, Russell Investments and BlackRock, have all filed with the Securities and Exchange Commission to launch new active funds in the near future.

For investors, two of the biggest selling points for actively-managed ETFs are the lower fees and transparency that they offer, say analysts. Unlike a mutual fund, whose value is set at the end of a trading day, these active ETFs will trade throughout the day, much like a stock -- or a passive ETF -- would. Plus, the active ETFs will disclose all their holdings at the end of each trading day. As for fees, active ETFs will carry higher expenses than a typical passive ETF, but potentially lower fees than many mutual funds.

The Dent ETF will consist of passive ETFs, including those that track the Standard & Poor’s 500 and foreign country indexes, says Rodney Johnson, the fund’s portfolio manager. The strategy of using many ETFs to create a portfolio is something many financial planners use. The Dent ETF’s expense ratio will be capped at 1.5%, high for an ETF but marginally lower than the average mutual fund.

How this latest entry into the nascent actively-managed ETF world will fare, is still uncertain, however. The first actively-managed ETF, Grail American Beacon Large Cap Value, which launched in May, attracted only $4.4 million in assets so far.

The Grail American ETF's investment managers say they've been looking for large stocks they feel are undervalued (JP Morgan Chase (JPM) is its top holding), much like the managers of an ordinary large-cap value fund would. The ETF's 0.79% expense ratio is about half the average open-ended mutual fund, although it is 20 basis points higher than the average ETF. Since its launch, the Grail ETF has returned 11.3%, slightly more than 11.1% return of the average large-cap value fund, according to Morningstar. But analysts caution that the good early performance doesn’t mean investors should run out and buy it. “A fund needs to have a track record, usually two or three years, before you can trust it,” says Curtis Teberg, portfolio manager of the Teberg Fund, an asset-allocation fund that uses ETFs.

The Grail fund is run by three different sub-advisors, partly to dissuade front-running, which is one of the biggest concerns for actively-managed ETFs, says Ken Leon, an S&P equity analyst. The concern is that as an actively-managed fund builds up a large position in a stock, over, say, a week, and reveals its purchases at the end of every day, other investors can mimic the strategy and run up the price of the stock. “By opening up their books every day do they lose the advantage mutual funds have of only showing their hand quarterly?” Leon asks. Wyatt Crumpler, vice president of American Beacon Advisors, says that there hasn’t been any indication of front-running so far.