Several investment advisory firms have recently registered a new breed of exchange-traded funds (ETFs) that they plan to bring to market later this year — actively managed ETFs.
What a surprise, another group of self-serving money managers — many of whom have historically under-performed the major stock market indices — have found yet another way to persuade investors into paying them an investment-management fee for what is likely to be inferior results.
As most of you know, all of the currently tradable ETFs are designed to track the performance of a specific financial index.
Many of these ETFs track the performance of a broad-based stock or commodity index, such as the S&P 500, Nasdaq Composite, or Dow Jones-AIG Commodity Index.
However, numerous ETFs have been brought to market during the past two years that track a much narrower group of assets. One is the iPath S&P GSCI Crude Oil Total Return Index ETN (OIL), which invests solely in West Texas Intermediate crude Oil Total Return Index ETN (OIL), which invests solely in West Texas Intermediate crude oil futures. Another is the streetTRACKS Gold Shares ETF (GLD), which invests only in gold bullion.
There are, too, several ETFs on the market that use so-called "enhanced-index strategies" to create their own unique financial indices. These funds then invest in securities that mimic the performance of those indexes.
For example, the Claymore/Sabrient Defender ETF tracks an index that invests solely in defensive equity securities. The Claymore/Clear Spin-Off ETF tracks companies that have been spun-off from larger companies.
Some families of ETFs work along specific lines: The First Trust family of ETFs employs fundamental measures (such as price-to-book value, price-to-cash-flow, and return on assets) to determine the types of stocks it uses to comprise a given index, as well as the percentage of those stocks held in the index.
Another, the WisdomTree family of ETFs, offers 38 enhanced-ETFs based on proprietary earnings and dividend-driven investment models.
Actively managed ETFs, however, will go a step further by letting their portfolio managers select the securities that will comprise a given ETF.
In essence, actively managed ETFs will be very similar to actively managed mutual funds, with the exception that investors will be able to trade those ETFs throughout the trading day rather than purchasing at the close of the market on any given day.
On Feb. 1, the Securities and Exchange Commission gave near-final approval to allow Invesco's PowerShares Capital Management unit to issue ETFs with securities that are chosen by a money manager, rather than just tracking an index.
Barclays and Bear Stearns are expected to receive similar authorization soon and offer managed ETFs by the beginning of March.
Although I expect some of these new-fangled ETFs to perform well over the coming years, I urge you to keep in mind that only around 15 percent of actively managed mutual funds typically outperform the major stock market indices in any given year.
Those funds that do turn in market-beating performance results tend do so for no more than two years in a row.
I also urge you to inquire about the expected expense ratios of any of the new, actively managed ETFs that come to market. My guess is that those expense ratios will be significantly higher than expense ratios for traditional ETFs. (Expense ratios are fund operating expenses that must be deducted from a fund's underlying investments. The result is that fund's net asset value.)
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