Actively Managed Exchange-Traded Products At Age Seven by Navigate Fund Solutions
The $20 billion currently invested in actively managed exchange-traded funds (AETFs) pales in comparison to the $11.51 trillion now held in actively managed mutual funds. This sharply contrasts with the success achieved by passively managed ETFs, which, over the last 7 years, have over $2 trillion. What’s impeding the success of AETFs?
AETFs have had a slow start and limited penetration due to the requirement to publicly disclose their full holdings each business day. A new white paper, by Navigate Fund Solutions (NFS), titled “Actively Managed Exchange-Traded Products at Age Seven” (attached) details two main reasons why daily holdings disclosure have impeded the success of AETFs:
- AETFs are susceptible to front-runners, which are traders that seek to earn short-term profits by buying and selling ahead of large investors whose trades they anticipate.
- AETFs are vulnerable to “free-riding,” which is the uncompensated use of a manager’s research or portfolio information by other investors.
Unlike AETFs, NextShares, developed by NFS, a subsidiary of Eaton Vance, are not required to publicly disclose their full holdings on a daily basis. NextShares, approved by the SEC, protect confidentiality with active management in a way that AETFs are not. Additionally, the white paper details why the SEC did not approve Precidian’s AETF structure on pages 9-10, as well as other concepts of AETFs.
The first actively managed exchange-traded product (ETP) was launched in March 2008. Seven years after initial introduction, first-generation active ETPs have total net assets of $19.46 billion. This represents less than 0.2% of the combined assets of actively managed mutual funds and active ETPs. The slow development of active ETPs primarily reflects the reluctance of fund sponsors to offer their leading active strategies in a format that requires daily disclosure of fund holdings. The pending launch of NextShares™ exchange-traded managed funds opens a new chapter in the development of active ETPs. Unlike first-generation active ETPs, NextShares are not required to disclose their daily holdings and can therefore maintain the confidentiality of fund trading information. Operating as NextShares, active ETPs can for the first time realize their full potential as alternatives to traditional mutual funds with built-in performance and tax advantages and the convenience of exchange trading.
Actively Managed Exchange-Traded Products At Age Seven – Introduction
March 25, 2008 marked a notable event in the history of the U.S. fund industry, the launch of the first actively-managed exchange-traded product (ETP). This followed by 15 years the introduction of the initial index-based exchange-traded fund (ETF) in January 1993. Although the first actively managed ETP — the Bear Stearns Current Yield Fund (YYY) — survived only a few months before being shuttered, its launch established a new era in active fund investing that continues to evolve. This paper provides an overview of the history of active ETPs, an assessment of current offerings and a view of their future.
The first active ETPs
Setting in motion the launch of the first generation of active ETPs was the decision by the U.S. Securities and Exchange Commission (SEC) to grant four investment advisers relief from certain provisions of the Investment Company Act of 1940, as amended (Investment Company Act), to permit them to offer actively managed exchange-traded funds (AETFs). On February 27, 2008, the SEC issued exemptive orders to each of Bear Stearns Asset Management, PowerShares Capital Management, Barclays Global Fund Advisors and the WisdomTree Trust granting the first AETF relief.
A condition of these and all subsequent AETF exemptive orders has been that the applicants represent that, prior to the opening of exchange trading in fund shares each business day, the fund will disclose on a free public website the identities and quantities of the portfolio securities and other assets held by the fund as of the close of the preceding business day. The SEC has deemed it necessary for actively managed exchange-traded products to disclose their current daily holdings so that market makers have sufficient information to perform their arbitrage function effectively.
The launch by Bear Stearns of the first AETF in March 2008 was followed in rapid succession by PowerShares’s introduction the next month of three equity and one short-term income AETF and WisdomTree’s launch of eight currency and short-term income AETFs in May and June 2008. Alas, only four of the 13 original actively managed exchange-traded products introduced in the first half of 2008 survive today. And these four surviving funds — WisdomTree’s Chinese Yuan Strategy Fund (CYB), Australia & New Zealand Debt Fund (AUNZ), Brazilian Real Strategy Fund (BZF) and Indian Rupee Strategy Fund (ICN) — all continue to struggle to attract investor interest. Exhibit 1 lists the initial AETFs brought to market in the first half of 2008.
After a year and a half of moderate launch activity dominated by specialty ETF managers, the AETF market attracted its first major fund sponsor when PIMCO introduced two actively managed exchange-traded products in November 2009. The first of these funds, the PIMCO Enhanced Short Maturity Active Exchange-Traded Fund (MINT), an ultrashort bond fund, has grown to become the largest AETF, with $3.66 billion in current managed assets.
MINT’s success had two important effects on the development of the AETF market — precipitating the introduction of a group of similar “near cash” funds by other AETF sponsors and fostering the development of a broader family of PIMCOsponsored income AETFs. Today, MINT and its seven progeny in the ultrashort bond category together manage $5.86 billion in net assets, accounting for 30% of total AETF managed assets and 7.2% of the combined net assets of actively managed ultrashort bond mutual funds and ETFs. Exhibit 2 shows the historical asset growth of ultrashort bond actively managed exchange-traded products and lists the eight currently offered funds in the category.
Following the launch of its first AETFs in November 2009, PIMCO has expanded its lineup of actively managed exchange-traded products to include a total of eight income funds with current net assets of $6.85 billion. PIMCO is today the largest manager of AETFs, with a 35% market share.
By far the loudest AETF launch to date was the February 2012 introduction of the PIMCO Total Return Active Exchange-Traded Fund (BOND). Managed initially by famed fixed income guru Bill Gross, BOND was billed as a nearclone of the PIMCO Total Return Fund, the largest mutual fund at the time of BOND’s launch. Riding the coattails of its legendary manager, BOND attracted considerable media attention and quickly grew to multi-billion dollar status. Following Mr. Gross’s abrupt departure from PIMCO in September 2014, BOND experienced investor outflows in conjunction with its mutual fund sibling. With net assets of $2.59 billion, BOND remains the second largest AETF. Exhibit 3 shows the development of BOND’s net assets since its launch in 2012.
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