AdvisorShares had filed an amended 485POS document with the SEC in June of this year which included a preliminary prospectus for the two funds. The funds were to be sub-advised by Emerald Rock Advisors, which was founded in Nov 2009. LOWP was intended as an actively-managed fund that would focus on small-cap securities, specifically those priced below $35/share and having a market cap below $500 million. In contrast, DIVI was intended to invest in strong, dividend paying companies and would have looked to outperform the total return of the S&P500.

Despite the withdrawal of these two funds, AdvisorShares still has three actively-managed ETFs that are still under filing with the SEC, each one with a different sub-advisor. In the past year, two new funds have made it to market from AdvisorShares’ pipeline – the Mars Hill Global Relative Value (GRV: 25.15 0.00%) and the WCM/BNY Mellon Focused Growth ADR (AADR: 26.30 0.00%). Of these, GRV in particular has tasted some success, quickly becoming the largest actively-managed equity ETF in the US as it stood at about $43 million in assets, at the end of August.
 
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However, the advantage cited there is that mutual fund investors get the exact NAV of the fund as opposed to ETF investors making the transaction at an “indicative price” that could be at a premium or discount to the actual fund’s NAV. In general, ETF shares will trade at a premium to NAV when demand is high and at a discount to NAV when demand is low. There is a mechanism that exists which is intended to keep the ETF’s price close to NAV. The designated broker to the fund has the ability to arbitrage between ETF price and the fund NAV and creating a profit for themselves. They do this by creating or redeeming ETF shares from the fund company, in exchange for the underlying basket of securities that the broker can buy from or sell to the open market. However, the broker would only do this if the discrepancy between the ETF price and fund NAV is large enough to compensate them for the transaction charge they pay the fund company when creating or redeeming ETF shares. As a result, in every ETF, a small premium or discount to the fund NAV will always exist because the designated broker does not have enough incentive to arbitrage that away. But how small is small?

When looking at actively-managed ETFs specifically, there have been claims made that Active ETFs will tend to have larger premium/discounts to NAV because of greater turnover in the fund and lower interest from market makers and designated brokers etc. We decided to look at exactly how Active ETFs in the US have fared in terms of keeping their ETF prices close to NAV. The table below looks at the number of days in Q2 2010 (63 trading days) that each Active ETF spent trading premiums or discounts of different magnitudes. And the chart below that shows the average distribution across all 26 actively-managed ETFs that traded in Q2 2010. The information is compiled from data disclosed on each fund’s websites. The premium/discount is calculated as the % deviation of the ETF’s mid price on market close from the fund NAV.

From the table, we can see that most equity focused actively-manged ETFs have not had trouble keeping their ETF prices close to NAV, except maybe AdvisorShares Dent Tactical ETF (DENT: 19.5501 0.00%), that has spent more days trading at large premiums or discounts compared to other equity ETFs. On the fixed-income side, Grail’s two bond funds have had a tendency to trade at a discount of bewteen 50-99 bps quite a lot. This doesn’t compare well with PIMCO’s bond ETFs that have what you could call a “perfect score” in this context, as none of their funds traded at premiums or discounts greater than 50 bps in Q2. However, the largest discrepancies are seen from WisdomTree’s currency funds that trade outside of the 50 bps mark with surprising regularity. The most glaring offender would be the Brazilian Real Fund (BZF: 28.21 0.00%) which spent only 35 trading days trading within the tight 50 bps band, and had 8 days where it traded at a discount greater than 100 bps. Clearly, this is something WisdomTree should be looking at.

On average though, looking at Active ETFs as a whole, 87% of the time the funds traded within the +/- 50 bps range, with very few occurences overall where funds traded at large premiums or discounts in exccess of 2% or 200 bps. This is isn’t much different from most traditional index ETFs. As such, Active ETF investors don’t need to be overly concerned. It is more important to know in which asset classes you are more likely to encounter larger premiums and discounts than normal and keep a look out for those before investing.
 
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Links: Website, Factsheet, Prospectus

Investment Strategy:

AADR is an actively-managed ETF that looks to achieve long-term capital appreciation above international equity benchmarks. The fund will invest in non-US companies that trade on US exchanges through American Depositary Receipts (ADRs). The fund is sub-advised by WCM Investment Management which analyzes major trends in the global economy in order to identify those economic sectors and industries most likely to benefit. The managers look at a time horizon of 3-5 years and believe in portfolio concentration. The portfolio will typically consist of fewer than 30 companies, but will have a minimum of 20 holdings, none of which will exceed more than 25% of the portfolio in weight. AADR’s primary benchmark is the BNY Mellon Classic ADR Index and its secondary benchmark is the MSCI EAFE Index.

Portfolio Managers:

WCM Investment Management is California-based sub-advisor that was established in 1976 and managed $1.4 billion in assets as of Mar 31, 2010. The individuals handling the day-to-day management of the portfolio are as follows:

Paul R. Black, Portfolio Manager – Paul is the President & co-CEO of WCM and has been in the investment business for 26 years. He helps define the firm’s investment strategy and has an active role in the selection of securities.

Kurt R. Winrich, Portfolio Manager – Kurt is the Chairman & co-CEO of WCM and has over 25 years of experience in the investment business. His primary responsibilities include portfolio management and equity research.

Peter J. Hunkel, Portfolio Manager, Business Analyst – Peter joined WCM in 2007 and has been in the investment business for 11 years, with previous experience at Centurion Alliance and Templeton Private Client Group.

Michael B. Trigg, Portfolio Manager, Business Analyst – Michael has 9 years of experience in the investment business and previously worked at Morningstar.

The Numbers:

Expense Ratio – 1.25%, including 0.75% in management fees. Expenses capped below 1.25% till May 6, 2011.

What’s special about it?

1. AADR is the only Active ETF that focuses on providing exposure through ADRs. By virtue of its mandate, AADR will end up having exposure to international mega-caps that are listed in the US like Nestle and Baidu.com, two companies which can be found in the fund’s top 10 holdings.

2. Partnering with BNY Mellon does give the fund a big advantage because BNY Mellon is the world’s largest depository for ADRs and is a leading source for international ADR market intelligence.

3. The fund’s sector and region diversification differs significantly from that composition of its benchmark indices – the BNY Mellon Classic ADR Index and the MSCI EAFE Index, but that’s where the managers hope to add value to the fund.

Analysis:

Positives –

- The managers, WCM Investment Management, have quite a strong track record in managing international portfolios. The prospectus highlights the performance of a “Focused Growth International Composite” that has similar objectives and investment strategies to the fund. The composite outperformed the MSCI EAFE by close to 9%, since inception in Dec, 2004.

Negatives –

- AADR’s expense ratio of 1.25% comes in at the high end of the Active ETF market, and it is only capped at 1.25% till May, 2011. The gross expenses for the fund are actually 1.29%.

- The portfolio concentration could lead to more volatile returns, implying greater upside during good times but also greater downside during bad times.

 
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Links: Website, Factsheet, Prospectus

Investment Strategy:

GRV is an actively-managed ETF that has an investment objective to exceed the total returns of the MSCI World Index with little or no correlation with the index. The fund does this by establishing long/short positions in other ETFs that provide exposure to certain groups of equities. The fund takes long positions in what they believe are the most attractive opportunities and then establishes an equivalent dollar amount of short positions in unattractive regions. By having a net market exposure of zero in the core of the portfolio, the fund’s sub-advisors – Mars Hill Partners – minimize market exposure and directional influences. However, the portfolio managers can use derivatives to add directional exposure of up to 50% net long or short on top of the core market neutral portfolio. This does mean that the fund may be leveraged in instances where it has a net long or short exposure, which is obtained through futures or swaps.

Mars Hill utilizes numerous multi-factor regression models to identify the highest and lowest probability opportunities and risks, with the primary driver being a dynamic ranking of four major regions – US, Europe, Asia and Emerging Markets.

Portfolio Managers:

Mars Hill Partners LLC is a Colorado-based investment advisor that is an affiliate of Huntley Thatcher Ellsworth Ltd (HTE) and was created in 2009 by principals from HTE. The day-to-day management of GRV will be done by the following portfolio managers:

James D. Huntley – James is the founding member of Mars Hill as well as HTE which he founded in 1997. Prior to that James worked spent 5 years advising affluent families and institutional clients for boutique firms.

David A. Houle – David is the Director of Research at Mars Hill and HTE and oversees strategy development, trading and risk management. He joined HTE in 2002.

Elliott J. Orsillo – Elliot joined Mars Hill in 2010 and HTE in 2009 after working with Russell Investments for 6 years as a portfolio manager.

Gregory L. Thatcher – Gregory joined Mars Hill in 2010 and HTE in 2000 after working for 15 years in the brokerage industry.

The Numbers:

Expense Ratio – 1.49%, including 1.35% in management fees. Expenses capped below 1.50% till Mar 14, 2011.

What’s special about it?

1. GRV is the first actively-managed ETF on the market that provides long/short exposure, giving the managers an opportunity to extract alpha not just from their long bets but also their short bets.

2. GRV has been able to attract investors very quickly. In the 1 month since the fund was launched, GRV has already gathered close to $39 million in assets, quickly making it the largest equity-focused active ETF in the US.

Analysis:

Positives –

- Having a core market neutral strategy allows the managers to avoid having a strong market exposure that long funds are exposed to. At the same time, the optional directional overlay gives the manager the ability to take advantage of a strongly trending market.

Negatives –

- GRV’s 1.49% expense ratio makes it the second most expensive Active ETF in the US, coming in after the Dent Tactical ETF (DENT), also run by AdvisorShares. The high expense ratio will be justifiable only if the managers are able to outperform their benchmark by a large enough margin.

- The advisor was only established in 2009, so there’s not much of a track record from funds that Mars Hill may have run previously, which investors can look to for reference.

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PIMCO’s Enhanced Short Maturity Fund (MINT) was launched in November 2009 and was the first actively-managed money-market ETF that strived to achieve returns on cash holdings better than the measly rates available in basic US treasuries. It served as an alternative to money-market funds for investors and portfolio managers looking to invest excess cash in portfolios. Given PIMCO’s well known fixed-income expertise and the ease of access provided through the active ETF structure, MINT proved to quite a success. The fund gathered close to $600 million in assets in the month of May alone and became the largest actively-managed ETF in the US. May was an especially volatile month for the equity markets as the S&P500 went from 1200 to 1070 and that was reflected in the scramble to move allocations to cash and money-market instruments like MINT.  At its peak, MINT’s market cap exceeded $800 million.

However, since then, as the markets bottomed in June started recovering in July, MINT started seeing massive outflows, presumably because investors moved allocations back into risky assets. Assets dropped to $650 million at the end of June and really fell in July, plummeting to about $330 million, easily making it the biggest loser in the Active ETF space. As we highlighted in June, MINT’s fortunes are likely to continue being dependent and inversely related to the fortunes of the general market. By virtue of its asset class, MINT’s asset base will be volatile, but it’s important to note that assets have not fallen back to the sub-$200 million level that MINT was at prior to its steep growth in May. And most significantly, MINT has been quite successful at its main objective, to provide total income and return than money-market funds. The chart below shows MINT’s healthy outperformance when compared to the SPDR Barclays Capital 1-3 Month T-Bill ETF (BIL), especially so in recent months.

In contrast to the MINT’s story, another brand new actively-managed ETF, the Mars Hill Global Relative Value ETF (GRV) saw nearly instant success in July. GRV was AdvisorShares’ second product launch that hit the market on July 9^th, with the Dent Tactical ETF (DENT: 19.5501 0.00%) being the only previous offering from AdvisorShares.

GRV hit the road running, gathering $38 million in assets in less than 3 weeks. While in the wider universe of ETF launches, that may not mean much, within the Active ETF space, that was enough to make it the largest equity actively-managed ETF in the US. While that may say more about the lack of success of other equity active ETFs than about GRV itself, it does indicate that investors like what GRV has to offer. The fund is unique in that it is the first actively-managed ETF to offer a long/short investment strategy that is usually accessible only through hedge funds. The portfolio managers will generally pursue a market neutral strategy but can opt to utilize derivatives to obtain a directional exposure to the market.

Initial reactions to GRV’s launch were mixed with some commentators questioning the complexity of the product and its utility for investors over long-only strategies. However, investors do seem to be voting with their money as the strategy clearly does appeal to some investors. The coming months will show whether the interest in GRV and assets continue flowing in. And of course, there’s the important matter of actually being able to provide the absolute returns that the sub-advisors claim to strive for.
 
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Investment exposure to international equities has traditionally been obtained by retail investors through passive ETFs such as the iShares MSCI EAFE Index Fund (EAFE: 0.00 N/A) tracking the MSCI EAFE index or the Vanguard Emerging Markets ETF (VWO: 42.50 0.00%) which tracks the MSCI Emerging Markets index. Thanks to a recently launched actively-managed ETF by AdvisorShares, investors can now access an international equities focused strategy that is actively managed, through an ETF. The fund is called the WCM/BNY Mellon Focused Growth ADR ETF (AADR: 26.30 0.00%), and it is sub-advised by WCM Investment Management. AADR focused on gaining exposure to large-cap, non-US equities by investing in American Depository Receipts (ADRs) which are the US-listed shares of non-US companies.

Morningstar’s Director of ETF Analysis, Scott Burns, spoke with portfolio managers from WCM Investment Management Group – Kurt Winrich and Mike Trigg. The Focused Growth ADR ETF achieves differentiation by pursuing a concentrated portfolio of just 20-30 securities that they believe in. As of July 28^th, 2010, the portfolio’s top 10 holdings included names like Baidu.com (BIDU) – China’s equivalent of Google, Walmart de Mexico (WMMVY.O) – Walmart’s Mexican unit as well as Nestle (NSRGY) and Hennes & Mauritz (HNNMY). On the point of portfolio concentration, Kurt Winrich said that, “We like to say if you’re going to beat the index, you’ve got to be different than the index. And yet you worry sometimes about risk in concentrated portfolios. And our argument is always that if you construct it well, and if you pay attention to getting the best companies in there, you actually can have lower risks than a lot of things that are dependent on commodity prices”.

Given the short history of this fund, it helps to look at past performance numbers on comparative portfolios. The prospectus for AADR highlights the past performance of a composite which represents 12 accounts managed by WCM with similar objectives, policies, strategies and risk to those of AADR. This composite has outperformed the MSCI EAFE benchmark in every period, including since inception (12/1/2004) by 7.55%. Commenting on the low turnover for the fund, Mike Trigg mentions that, “The portfolio has been around for five years on the separate account side, and there are 24 names in the portfolio. And close to half of those have been in the portfolio since the inception”.

However, AADR comes in on the higher side of the expense scale, as do most of AdvisorShares’ Active ETFs, with a net expense ratio capped at 1.25% until May, 2011. Of this, 0.75% goes to the sub-advisors as management fee.
 
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The Focused Growth ADR ETF (AADR) will look to achieve capital appreciation and beat benchmarks such as the MSCI EAFE and the BNY Classic ADR Index. The fund is sub-advised by WCM Investment Management that currently has $1.4 billion in AUM has historically achieved quite a stellar performance on their international portfolios. The prospectus provides the performance of a “Focused Growth International Composite”, which represents 12 accounts managed by WCM with similar objectives, policies, strategies and risk to those of AADR. This composite has outperformed the MSCI EAFE benchmark in every period, including since inception (12/1/2004) by 7.55%. Another important point to note is that this fund is relatively concentrated in its holdings, with the portfolio managers aiming to hold just 20-30 securities which focus on the technology, health care and consumer staples sectors. AADR will have a total MER of 1.25%, which includes a management fee of 0.75%. Some of its top holdings on the first trading day included China’s Baidu.com (BIDU), Walmart’s Mexican division (WMMVY.O) as well as Nestle (NSRGY).

AlphaPro’s Global Dividend ETF (HAZ) will be managed by Guardian Capital, a 40 year old investment manager that is currently managing $13.4 billion in assets. HAZ will look to achieve regular dividend income with modest capital growth through global equity investments. AlphaPro focused on the international scope of the portfolio, pointing out that most Canadian investors only invest in Canadian-dividend paying stocks – an expected home country bias. Ken McCord, the President of Horizons AlphaPro said, “Canadian companies represent only a small share of the world’s companies. Having global exposure gives an investor the opportunity to buy the world’s best dividend stocks”.  It’s a commonly cited fact that a large chunk of stock returns result from dividends. Guardian Capital’s research puts a number to this – 60% of Canadian stock returns and 63% of US stock returns in the last 30 years have come from dividends, figures that cannot be overlooked. The Global Dividend ETF will have a management fee of 0.80% but will also pay 20% “performance fee” on the amount by which the fund outperforms its benchmark – MSCI World Index. The portfolio managers will also look to hedge 50% of the fund’s non-C$ exposure.
 
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Noah Hamman, CEO of AdvisorShares, has also made clear that his firm intends to bring strategies to investors that are different from the norm and offer a unique investment option and value proposition. That strategy has certainly been evident from AdvisorShares’ planned product line-up, which ranges from a high yield bond fund, to an ADR-focused investment strategy and now a short-only fund.

The Active Bear ETF will select a portfolio of securities on a short-basis only by looking to indentify securities with low earnings quality or aggressive accounting methodologies intended to hide poor fundamentals. It’ll also search for downward earnings revisions and reduced guidance in identify earnings driven events that could contribute to a stock price decrease. The fund will normally invest in 20-50 short securities, each of which can comprise 2%-7% of the portfolio.  HDGE will be sub-advised by Dallas based Ranger Alternative Management which was established in 2008. The lead portfolio manager on the fund, John Del Vecchio, previously managed segregated short-only portfolios. The preliminary prospectus reflects the historical performance constructed together to show returns from Oct 1, 2007 till Mar 31, 2010. The “Ranger Short Only Portfolio” has returned 16.55% since Oct 1, 2007, compared to the S&P500 Index which is down 8.01%. On an yearly basis, as you would expect, in 2008 when the market crashed, the short portfolio returned 94.85% while the S&P500 was down 37%, but in 2009 when the market rallied, the portfolio returned -28.99% when the S&P500 was up 26.46%. The expenses of the Active Bear ETF were not yet disclosed.

The Active Bear ETF will likely be an investment strategy suitable for investors that want to make a clear directional bet on the market. In the market environment of the last 2 years, the direction of individual equity securities has been dictated much more by the general market than by security specific factors. This was evident from the historical performance included in the prospectus where the fund did very poorly in 2009 when the market had a steady upward trend since March. If the market is going up strongly, then shorting the companies that you expect are poor fundamentally would still be akin to swimming upstream in very fast flowing river. Having said that, given the current market concerns regarding global debt levels and the precarious nature of the recovery, the introduction of the Active Bear ETF could be very well-timed indeed.
 
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The Mars Hill Global Relative Value ETF is quite unique in that it will be the first actively-managed ETF to pursue a long/short equity strategy, making it an absolute return vehicle that will aim to create alpha regardless of the market environment. The fund managers will invest in equities globally which also broadens the potential scope for alpha returns. The ETF’s performance is benchmarked to the MSCI World Index. GRV will have a total expense ratio of 1.49% including a management expense of 1.35%, which is comparable to AdvisorShares’ other listed product, the Dent Tactical ETF (DENT: 19.5501 0.00%) which charges 1.56%. The net expense ratio on the fund is contractually kept below 1.50% through the Advisor reducing its fee, until March 14, 2011, after which you could see changes in expenses. Mars Hill, the Colorado based sub-advisor, will be paid in a tiered structure, with their compensations ranging from 0.90%-1.00% depending on the amount of assets in the fund.

Another notable detail is that GRV will implement its strategies using other ETFs that offer it the desired exposure, meaning it will have a “fund of funds” structure. Even though the portfolio will usually be market neutral, the portfolio managers have the ability to use derivatives to leverage the fund in order to provide directional exposure of up to 50% on top of its core portfolio.

GRV faced some hurdles getting to market, not least due to the SEC’s investigation into the use of derivatives into all forms of ETFs, especially levered, inverse as well as actively-managed ETFs. Back in March, Fund.com – the parent company of AdvisorShares – had given indication that the firm expects to see 2 more of their Active ETFs on the market by the end of April, with the two funds being GRV and the WCM/BNY Mellon Focused Growth ADR ETF (AADR). However, in an interview with IndexUniverse’s Cinthia Murphy, Noah Hamman, the CEO of AdvisorShares, mentioned that the SEC’s investigation had definitely slowed things down for them. The SEC’s investigation hit not just AdvisorShares’ planned launches but also those of nearly every other Active ETF issuer as only 1 new actively-managed ETF had hit the market since February, prior to today.

AdvisorShares still has active filings with the SEC for 5 more actively-managed ETFs with 4 different sub-advisors – Emerald Rock Advisors, Peritus Asset Management, Cambria Investment Management and WCM Investment Management. That gives AdvisorShares’ one of the deepest pipelines for products in the Active ETF space.
 
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The new fund will attempt to grow capital by investing across every major asset class – US equity, foreign equity, fixed-income, real estate, commodities and currency markets. There was no disclosure made of the fee structure of the ETF, but we can probably expect the expense ratio to be higher than the average actively-managed ETF because there’s only 2 existing Active ETFs on the market that provide a multi-asset class exposure – the iShares Diversified Alternatives Trust (ALT: 50.15 0.00%) and the AdvisorShares’ own Dent Tactical ETF (DENT: 19.5501 0.00%). The managers will implement their strategy by investing in other ETFs that provide the desired exposures. The fund is looking to achieve absolute returns which implies a positive return regardless of the general market direction.

GTAA will be sub-advised by Cambria Investment Management and the two portfolio managers of the fund will be Mebane Faber, CIO of Cambria and Eric Richardson, CEO of Cambria. Mebane Faber is the author of the book “The Ivy Portfolio” and also writes on a well-frequented blog called World Beta at http://www.mebanefaber.com/. The Global Tactical ETF will utilize a quantitative trend-following approach in managing the portfolio. As with all actively-managed ETFs in the US, the fund will disclose the portfolio holdings on its website every day after close of trading.

Cambria is based out of California and was set up in 2006. As of June 2010, it managed $26 million in assets. The prospectus provides some details on the historical track record of the Global Tactical Asset Allocation composite which has largely similar strategies and objectives. The composite, with an inception date of March 1, 2007 has outperformed its “blended benchmark” since inception by an impressive 6.69% and outperformed the S&P500 by 7.34%, on an annualized basis. In the last 1 year though, the Global Tactical Asset Allocation composite returned 11.24% where the S&P500 returned 47.28%, which gives an indication that this portfolio might be a good holding when down markets, but could underperform in upward trending markets.
 
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