ActiveETFs | InFocus » Grail Advisors

Grail Advisors Details Western Asset Ultra Short Duration ETF (GWLQ)

Shishir Nigam — Wed, 01 Sep 2010 11:00:16 +0000

On August 31^st, Grail Advisors filed a detailed prospectus with the SEC pertaining to a new actively-managed ETF called the Grail Western Asset Ultra Short Duration ETF, which will have the ticker GWLQ. Grail first filed for this product back in May and back then it planned to call the fund the “Grail Western Asset Enhanced Liquidity ETF”. The detailed prospectus now includes more information such as the expense structure for the fund and also provided disclosure on past performance of composites managed by Western Asset with similar strategies.

The investment mandate for the fund has not changed, and the Ultra Short Duration ETF will look to achieve maximum current income and preservation of capital by investing in short-term, investment grade fixed-income securities. Reflecting the short-term nature of the fund, the average duration of the portfolio is expected to be less than 1 year. The fund will be sub-advised by Western Asset Management Company, which is a California-based firm associated with Legg Mason Asset Management, that manages more than $478 billion in assets. Western Asset focuses its management expertise entirely on the fixed-income market. For the fund, Western Asset will employ an active, team-managed strategy and utilizes a top-down economic and interest rate outlook, combined with a bottom-up security selection process. The portfolio will be managed by a team of 4 managers who will be allowed to invest in debt issued by governments of Western Europe, Australia, Japan and Canada, aside from investing in US government and agency debt. However, all investments will be restricted to US$-denominated securities.

The Ultra Short Duration ETF will charge total expenses of 0.30%, which consist of 0.23% in management fee that goes to Western Asset. The total operating expenses are 0.42%, but an expense reduction has been put in place till August 31, 2011 to cap expenses at 0.30% for the first year of the fund. That fee structure will put in direct competition with PIMCO’s Enhanced Short Maturity Fund (MINT: 100.76 0.00%) that has seen a lot of success since launch. MINT has an expense ratio of 0.35%, so clearly the pricing for this new fund was decided upon with an eye upon the competition.

The prospectus also details the performance of a “Western Asset Enhanced Liquidity Composite” that represents performance for funds that are substantially similar to the planned Ultra Short Duration ETF. Since inception in Jan 1994, the composite has returned 4.18% compared to the benchmark’s 3.99%. This marks a marginal outperformance of 0.19%. The benchmark is a blended index consisting of a two-third weighting in the Citigroup 3 Month T-bill and one-third in the Barclays Capital U.S. Government Bond Index 1-3 Years. However, the composite underperformed this benchmark by about 40 basis points during the last 1 year and 3 year periods.

If this actively-managed ETF does end up gaining some traction, then it will become another money-market alternative that they can turn to for putting away their cash, aside from PIMCO’s MINT. Other firms like Eaton Vance have also filed to launch actively-managed ETFs which target the short duration segment of the bond market.

Disclosure: No positions in above-mentioned names.

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How Large Are Active ETF Premium/Discounts To NAV?

Shishir Nigam — Tue, 24 Aug 2010 11:00:01 +0000

A big difference between exchange-traded funds (ETFs) and mutual funds is the ability to trade in the ETF intraday on the exchange. Investors can see an indicative price for the fund at any point during the trading day and purchase or sell the fund just like they would a stock, using margin, limit orders etc. This is compared to mutual funds investors who can only sell or buy fund shares or units at 4pm on market close and that to at a price that they will not know until after the fact, once the net asset value, or NAV, is “struck”.

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: 19.52 +0.26%), 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: 28.09 +0.11%) 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.

Disclosure: No positions in above-mentioned names.

Grail Advisors, RiverPark Shutter Two Active ETFs

Shishir Nigam — Mon, 23 Aug 2010 10:53:29 +0000

The Active ETF space in the US is now starting to see some of the attrition that had long been expected to occur in this relatively new space. On August 20^th, Grail Advisors announced in a press release that they will be shutting down two of their actively-managed ETFs – the RP Technology ETF (RPQ: 26.59 0.00%) and the RP Financials ETF (RFF: 24.56 0.00%). The closure of the funds was approved at a board meeting and the funds will be suspended prior to market open on Aug 30, 2010.

The closure of these funds makes them the first to be closed in the US Active ETF space, since the very first actively-managed ETF from Bear Stearns went down with the company in 2008. The RP Technology and the RP Financials ETFs were both launched in October 2009, as part of a group of 4 Active ETFs that also included the RP Growth ETF (RPX: 26.01 0.00%) and the RP Focused Large Cap Growth ETF (RWG: 26.855 +1.53%). The two funds that are being closed had seen hardly any in flows since their launch, with both of them languishing around the $2.5 million mark, majority of which is likely the seed capital that the funds started off with in the first place. Both funds had an expense ratio of 0.89% and RFF aimed to outperform the S&P Financials Index, while RPQ aimed to outperform the Nasdaq Composite. RPQ was able outperform its benchmark by a significant margin since inception, but RFF had a harder time and generally stuck quite close to the performance of its benchmark index.

Both funds were sub-advised and managed on a day-to-day basis by RiverPark Advisors, run by CEO and Managing Partner, Morty Schaja. He commented, “By all appearances, the marketplace is not ready for these sector funds. We’ve been pleased with the performance of the RP Technology ETF but flows have still been disappointing. I believe investors will be better served by incorporating the best ideas of these two sector funds into our RP Growth ETF (RPX) offering”. That might imply that RiverPark and Grail Advisors plan to push on with the RP Growth ETF for the while being, even though that fund has not tasted much more success than the two funds being closed. RPX’s assets stood at $3.96 million as of July 31, 2010. The CEO of Grail Advisors, Bill Thomas, also chose to direct attention to future possibilities, saying that, “With this move, we are dedicating our resources to the areas of most interest to investors, including the introduction of several exciting new funds in the coming months that will have broad appeal in the marketplace”.

Many such new funds are not profitable for fund companies until they cross a certain threshold in assets. The threshold to achieve that break-even is seen to be around $30 – $50 million, but for small scale players like Grail Advisors, that threshold is likely on the higher end of the range because they don’t benefit from the scale efficiencies that larger ETF manufactures like Invesco PowerShares have. At the moment, the largest of Grail Advisors’ seven actively-managed ETF is the RP Focused Large Cap Growth ETF (RWG) with assets of only $6.65 million. So it is quite likely that each of Grail’s current offerings are loss-making propositions for the company. RiverPark, the sub-advisor to four of Grail’s ETFs, has filed with the SEC to launch its own actively-managed ETFs as well and has 3 different Active ETFs in the works.

Disclosure: No positions in above-mentioned names.

3 Reasons Why Bond ETFs Are Dominating Active ETF Landscape

Shishir Nigam — Thu, 19 Aug 2010 11:00:35 +0000

In the 2 years that actively-managed ETFs have been around, there have been funds launched that focus on various asset classes, ranging from equities and fixed-income to currencies and commodities. While equity focused actively-managed ETFs are the most numerous in number, they certainly haven’t seen as much success as funds focused on other asset classes. The graphic below shows a snapshot of the asset class break-up within the Active ETF landscape at the end of July.

While WisdomTree’s currency ETFs have been successful at gathering the lion’s share of assets in the Active ETF space, their actively-managed ETFs are essentially seen by many investors as money-market funds. Active fixed-income ETFs had 23% of assets at the end of July, while equity focused active ETFs had a measly 5% share, even though that category is made up 11 different ETFs. Cumulatively, these active equity ETFs held just in excess of $100million in assets. So what exactly has been behind the success of fixed-income focused actively-managed ETFs relative to equity focused products?

Effectiveness of active management in fixed-income securities

The first idea that can explain the relative difference in success rate is that, traditionally, active management is seen to be more effective within the fixed-income market, as opposed to equities. There are more inefficiencies in the bond market for active managers to exploit than in the stock markets, with liquidity differences being one of the factors that brings about exploitable inefficiencies. As such, fixed-income managers are able to add alpha over their benchmarks more often than not, whereas within equities, active managers have a much harder time outperforming indices. This has been reflected in the success that PIMCO’s 3 actively-managed bond ETFs have seen, with one being a money-market alternative and the other two funds focusing on the municipal bond market. These funds have been relatively more popular because of the access they provide to PIMCO’s active management expertise in the bond market. And have these fund actually been successful at outperforming? Of the 3 funds, only PIMCO’s Enhanced Short Maturity Fund (MINT: 100.76 0.00%) has been able to beat its benchmark, while the other two municipal bond funds have lagged their benchmarks marginally, since inception.

Less impact of daily disclosure requirement in fixed-income than equities

The second big factor is the effect of the daily disclosure that is required by actively-managed ETFs of all holdings. Most active managers, especially equity managers, have been reluctant to meet this stringent requirement because they fear exposing their alpha generating strategies to competitors. In a recent interview with ActiveETFs | InFocus, Patrick Daugherty, who worked behind the scenes on the launch of the first actively-managed bond ETF from Bear Stearns in 2008, shared his thoughts on the effect of the daily disclosure requirement on active managers. He said, “There’s no doubt it discourages some of them because sophisticated and active traders whom I speak to, who have been known to do other things that require capital and human resources, have told me that this is the reason they have not gone into this field”. If any equity manager wants to build up a position and exit a position over several trading days, then that move would be visible to outsiders through the daily disclosure of holdings. As a result traders could potentially monitor the positions being changed and front-run the moves made by the active manager, resulting in sub-par pricing for the fund. The bond market though has a lot more depth compared to equity markets. For example, the municipal bond market comprises of tens of thousands of different issues which means that holdings in different funds can vary extensively. As a result, knowing what bonds a fund holds may be very helpful for an outside trader. Due to this, managers behind and investors in fixed-income funds have been far more comfortable with the disclosure requirements of Active ETFs.

Presence of reputed managers in fixed-income, not in equities

The third and probably most important factor has been the lack of star managers running Active ETFs within the equity space. As most investors would tell you, when it comes to active management, the biggest pull factor is nearly always the reputation of the managers behind the fund and their track record. The fixed-income space has seen several strong and well-reputed managers get behind actively-managed ETFs. One example is, of course, PIMCO which has attracted a lot of assets into its Active ETFs by virtue of its reputation in the bond market, as mentioned earlier. Grail Advisors also recently announced a partnership with DoubleLine, run by the renowned fixed-income manager, Jeffery Gundlach. In the equity landscape though, there has been nothing comparable to attract investors to actively-managed equity ETFs. The industry is still waiting for a Bill Miller, or an equivalent, to get interested in the Active ETF space.

Disclosure: No positions in above-mentioned names.

Actively-Managed ETFs Lack Track Records

Shishir Nigam — Fri, 06 Aug 2010 11:00:43 +0000

One of the biggest concerns voiced over actively-managed ETFs has been their lack of strong track records. Many market commentators, including Lisa Valentine, Managing Editor for FSOkx.com, have expressed reservations and cautioned investors from investing in Active ETFs for that reason. When it comes to active management, investors always look to the manager track records and often Morningstar ratings to get a gauge of how they can expect the fund to perform.

Morningstar issues ratings for active funds once they have been around for 3 years or more. That timeframe is what is seen as sufficient for a fair assessment of an active manager’s capabilities with respect to their benchmarks. However, the oldest actively-managed ETFs that are currently on the market in the US, the batch of four PowerShares Active ETFs, were only launched in April 2008. This means that the first actively-managed ETFs to receive Morningstar ratings would not get them before April 2011. Until then, investors will justifiably have reservations in investing in these “un-tested” products. To their credit though, some actively-managed ETFs have already shown signs of being up to the mark. ETFbase.com points out the performance of the PowerShares Active AlphaQ ETF (PQY: 24.20 +1.21%) which currently has around $21million in assets but has been able to outperform its benchmark in both up and down markets. PQY has beaten its benchmark, the Nasdaq 100 Index, in each of the observed time frames in the last 12 months.

However, this initial challenge of short track records is a hurdle that all active funds have to face, regardless of whether they are found in an ETF structure or a mutual fund. And despite this, as Lisa points out in her note, many big names such as T. Rowe Price, John Hancock and Legg Mason have registered with the SEC to launch more actively-managed ETFs.

One novel strategy that several issuers are employing to avoid the painful and lengthy process of establishing a track record for a new Active ETF is conversion of existing mutual funds into actively-managed ETFs. This strategy was first proposed by Grail Advisors which is still in talks with several undisclosed funds with regards to conversion. Then in July, Huntington Asset Advisors came out and announced that they will roll one of their existing mutual funds into an actively-managed that they have filed with the SEC for. Namely, Huntington’s Rotating Market Fund (HRIAX) will undergo conversion into an ETF once the ETF is launched. What this means is that the Rotating Market Fund’s 9-year track record will get carried over to the new actively-managed ETF, as will its existing Morningstar ratings, because the new ETF will be managed by the same manager to the same investment mandates.

Given how much difficulty new Active ETF launches are having due to the lack of a track record, Huntington’s new ETF will have a huge leg-up over competition when it enters the arena. Other issuers though will continue to have a tough first few years and shouldn’t have very high asset growth expectations up-front.

Disclosure: No positions in above-mentioned names.

ALPS Advisors Files Papers For Global Fixed-Income Active ETF

Shishir Nigam — Tue, 27 Jul 2010 11:00:45 +0000

On July 22^nd, ALPS Advisors filed a preliminary prospectus for an actively-managed ETF that will focus on investing globally in fixed-income securities. The fund will be called the RiverFront Strategic Income Fund. ALPS Advisors was one of the first companies to actively market ETFs to the financial adviser community when ETFs were first launched in the US in the 90s. ALPS currently manages $92 million in ETF assets as of June 2010, according to NSX data, amongst 6 different ETFs. ALPS also acts as the distributor for the Select Sector SPDR ETFs as well as funds from United States Commodity Funds such as USO and UNG.

The investment advisor on the planned Active ETF will be Grail Advisors, the company that has provided a platform for various companies to launch their actively managed funds as ETFs. The sub-advisor on the fund will be RiverFront Investment Group, which was established in 2008 by the former CIO of Wachovia Securities. RiverFront is based out of Richmond, Virginia and managed $1.8 billion in assets as of March 31, 2010. The portfolio will be invested in global fixed-income securities of all types, origins and currencies. The prospectus casts a very wide net with regards to securities that the fund may invest in as there is no credit rating criterion that has been established and the fund may be entirely invested in junk bonds if the managers choose to do so. One restriction that is in place disallows the fund from investing more than 25% of assets in any one industry. ALPS will act as the “administrator” for the ETF.

RiverFront Strategic Income Funds’ total operating expenses will be 0.24% but it is kept at that level only thanks to a fee waiver of 0.25% on the part of Grail Advisors that will be effective for at least 18 months.

Such a fund could definitely be a complementary part of a portfolio that is largely made up of equities, providing diversification through international bond investments. There are now several actively-managed ETFs in the works that will provide investors with exposure to international and especially emerging market bonds. These include the Grail DoubleLine Emerging Market Fixed Income ETF and WisdomTree’s Emerging Market Local Debt Fund, both of which are under filing with the SEC.

Disclosure: No positions in above-mentioned names.

How About An Actively-Managed Financial Sector ETF?

Shishir Nigam — Fri, 23 Jul 2010 11:00:16 +0000

Roger Nusbaum, who runs the popular blog Random Roger, wrote in a post today that one area in which an actively-managed ETF could add some value is the financial sector. Roger makes the point that the financial sector is exactly the type where some active management would be beneficial to investors because of the number of potentially bad bets out there amongst banks. I couldn’t agree more.

Passive indexing appeals to many because of its simplicity and straight-forward approach to investing of holding all the securities in index. Simplicity sounds very good in theory but in reality, it’s not the best recommendation in certain situations, as Roger illustrates. Most passively-managed financial sector ETFs would hold all the big names like JP Morgan, Bank of America, Citigroup and other big global banks, just because they are obligated to track the indices. The indices in turn include all those securities as components in order to meet their objective of being a good representation of the sector. Looking at that carefully, you’ll notice that neither the objective for the index (to be a good representation of the sector) nor that for the passive ETF (to track the index closely) has anything to do with picking the “right” investments for investors. And therein lies the issue when it comes to investing passively in sectors that represent minefields more than they represent investment opportunities. And this is especially true when you hold index ETFs that are cap-weighted. For example, if you invested passively in the financial sector using the Financial Select Sector SPDR Fund (XLF) on July 21^st, you’d end up holding more of Citigroup (5.69%) than of Goldman Sachs (4.84%). Anyone who has followed the markets in the last 2 years would never in their right mind make such an allocation, given the market dominance of Goldman Sachs and the severe ongoing troubles of Citigroup. An active manager operating an actively-managed financial sector ETF would be able to make those choices instead of being forced to provide the investor with market cap weights of each security in the sector.

Of course, one actively-managed ETF for the financial sector already exists – in the form of Grail Advisors’ RP Financials ETF (RFF: 24.56 0.00%), which was launched in October, 2009. According to numbers from Google Finance, RFF has been able to outperform the Financial Select Sector SPDR (XLF) by about 100 basis points since inception. And looking at the holdings, where in XLF, 5.69% of your money would have been in Citigroup, RFF does not even hold Citigroup in the portfolio. Which specific active manager you end up choosing is, of course, another debate all together. RFF, for instance, is still very light on assets, has a short track record and little investor recognition.

To further the original point though, some of the most successful actively-managed ETFs provide investors with exactly the value-add highlighted above – the ability to utilize the expertise of an active manager in a sector where it would be most useful in avoiding pitfalls. For example, PIMCO’s Enhanced Short Maturity Fund (MINT: 100.76 0.00%), which is the 2^nd largest fund in the Active ETF space, operates in the short-end of the yield curve, providing cash management solutions through investments in money-market instruments. Dislocations in the cash market through the credit crisis have made investing in money-market securities less reliable, thus making an actively-managed money-market fund more suitable than a fund tracking a passive money-market index. Another instance where Active ETFs are more relevant is the municipal bond market. In a time when huge budget deficits are the norm across US states and cities and states have even issued IOUs, the credit quality of the issuer becomes a key factor when investing in municipal bonds. A credit manager who has the ability to distinguish the nearly bankrupt municipalities from those with strong balance sheets would again definitely add value over a passive municipal bond index.

To sport some other ideas on areas where active management could come in handy – emerging market equity, emerging market bonds, high yield bonds and maybe even real estate could be areas where holding a representative index of the sector might not be the best idea.

Disclosure: No positions in above-mentioned names.

DoubleLine Partnership With Grail A Huge Win – Bill Thomas, CEO Grail Advisors

Shishir Nigam — Wed, 14 Jul 2010 11:00:47 +0000

Active ETFs | In Focus spoke in-person with Bill Thomas, who is the CEO of Grail Advisors. Grail currently has 7 actively-managed ETFs on the market and just recently announced a partnership with DoubleLine Capital, which is lead by the respected fixed-income manager – Jeffery Gundlach. Bill talks to us about their new partnership, Active ETF disclosure, prospects for mutual fund conversions.

Click here to see the full video interview. Alternatively, find the transcript of the interview below.

Shishir Nigam – ActiveETFs | InFocus: The Active ETF space in the US has seen lots of action since the last time we chatted. How do you think the prospects for this field are evolving?

Bill Thomas – CEO, Grail Advisors: I think we’re just in the forefront of this thing really taking off. There’s about a billion dollars in actively-managed ETFs and that all really started just over a year ago in May with the launch of the American Beacon product in partnership with us. And I think you’re seeing more and more firms get into it and we’re just at the beginning of the first innings, to use a baseball term, very very exciting.

Shishir: Do you think the continued stagnation of assets for most Active ETFs, other than those from PIMCO, is a sign of poor traction for these products?

Bill: I think it’s been a very difficult investing market, the market today was off significantly with the downfall. So I think it’s a challenging market to put any product up into the market, but what you’re seeing is that if you’ve got the right product and the right strategy, you’re able to gather assets. And PIMCO’s MINT is perfect example of that – you’re in a low yield environment, where investors are looking for a little extra return, willing to accept limited fluctuation of the net asset value and that they are starting to really focus on the fact that transparency, liquidity and tax efficiency are major investors points that are of interest.

Shishir: Is Grail’s partnership with DoubleLine, run by Jeffery Gundlach, a major step forward for the company?

Bill: It’s a huge win and especially that win with Jeffery Gundlach and his team that had come over from their previous employers, really just fantastic. They are the fastest growing money manger in the United States. They’ve just surpassed a billion dollars on their Total Return mutual fund, last they announced on Friday. There’s just tremendous amount of momentum and a tremendous amount of excitement about what they’re doing. So I think coupled with DoubleLine and the news that we had about a month ago about Western Asset Management, what we’re seeing truly the real brand players are coming into this space and doing so with utilizing the platform that we’ve built at Grail Advisors.

Shishir: How big of an issue are the daily disclosure requirements for prospective issuers when launching Active ETFs in the US?

Bill: It’s been interesting to see how different firms deal with this. And what I find is that this is a cultural decision of the investment management firm and you’ve got certain firms that really see this as a non-starter. If I need to be fully transparent, I’m not going to do it. And what you’re seeing is other firms have comfort in doing it and those firms probably participate in managed account programs and separate account wrap programs. They see the opportunity while other firms struggle with that decision to really get into the business and gather assets with the belief that eventually we’re all going to get there anyway. And that’s where I think the first mover advantage is significant.

Shishir: Are there ways in which the Active ETF structure could be improved?

Bill: I think that the SEC has done an incredible job getting us to this point, given everything and the creative ideas that get thrown in front of them on a daily basis. I think what’s neat is that we’ve got a wonderful structure that’s working today, has operated efficiently and it’s to the end of benefit of the shareholders – which is their job to protect and our job to deliver to – that transparency is truly a wonderful benefit for them.

Shishir: I guess the other side of that story would be, if because of the transparency, the manager’s end up losing some of their edge, then ultimately the shareholders at the end of the line also end up losing in some way?

Bill: I’ve never seen homework that actually said that having a fully transparent portfolio is to the disadvantage of shareholders. With that said, I’ve never seen research that said fully transparent is an advantage to the shareholders. That’s where I truly think it’s a cultural issue between the firms and I think that certain firms have made that leap into the managed account space or into the model programs so it’s a natural step to make that next step in actively-managed ETFs.

Shishir: Are you seeing greater openness to the idea of mutual fund conversion into actively-managed ETFs from providers as well as investors?

Bill: Yes, we’ll probably be announcing within a month a conversion of a separate account manager who’s going to convert their program into an ETF. You’ll probably see a closed-end fund do it as well. And then we’ve been working with several mutual funds that are looking to do it and they certainly want to get their first because they see the benefit of being the innovators. So we expect to get something done here probably some point in the third quarter.

Shishir: How can these products become a more integral part of advisor portfolios given the current incentives that financial advisors have to recommend mutual funds instead?

Bill: Well, I think the mutual fund industry has really moved away from selling their products with loads. If you look at the business in A-shares, probably 80%+ of A-shares are actually sold without a load at NSF value. And I think what you’re seeing everybody is moving to these fee-based wrap accounts where the broker is getting compensated on the overall portfolio, not on the product. Now, ETFs fit perfectly in that spot because it’s a low cost way to get access to those particular strategies, certainly on the passive side, now emerging on the active side. So I think that the model has changed and ETFs actually feed perfectly into the new model.

Shishir: What would you say are the main challenges for the Active ETF space in the next 2 years?

Bill: I think it’s to continue to educate investors and advisors. If I can rewind the clock 2 years ago from when we started Grail Advisors, I knew education was important but I thought given the resources that a lot of our other fellow firms in the ETF space had put into it, I thought the education they had done was superb and everybody would know what an ETF is, regardless whether it was active or passive. I’ve been surprised that that’s not the case. So I think we all need to continue to focus on education. Certainly, it’s a core issue for us, how do you trade ETFs, how do you utilize ETFs, and again that’s regardless of whether it’s active or passive.

Shishir: That’s fantastic, Bill. Thanks a lot for sharing your thoughts.

Bill: Thank you, thank you for having me.

Disclosure: No positions in above-mentioned names.

BlackRock iShares’ Big Move: Active ETFs With Reduced Disclosure

Shishir Nigam — Mon, 28 Jun 2010 12:00:57 +0000

As we discussed different ways in which the actively-managed ETF structure could be improved, one of the biggest concerns that was recognized had to do with the degree of disclosure required by actively-managed ETFs in the US. Active ETFs in the US are regulated such that issuers and managers need to provide complete disclosure of their holdings with a 1-day lag. The problem that creates for managers and the resulting reluctance of issuers to enter the Active ETF space is significant as managers fear their portfolio strategies being copied and front-run, as voiced by several major names like PIMCO and Janus Capital highlighted in the article.

Reported by Bloomberg, BlackRock iShares – by far the largest issuer of ETFs in the world – is now seeking approval from the SEC for actively-managed ETFs “that would keep some of their assets undisclosed”. If such a modification to the Active ETF structure gets approved by the SEC, many issuers and managers would be much more comfortable in bringing strong active managers to the Active ETF space without fear for their strategies being front-run. In more than 2 years of existence, the Active ETF space has not seen the arrival of big name active managers operating funds within the ETF wrapper. Only very recently has there been some promise of that changing, with Grail Advisors forming a partnership with DoubleLine which is lead by the illustrious Jeffery Gundlach, a fixed-income manager who is spoken of in the same company as Bill Gross. However, even then, the actively-managed emerging market bond ETF that Grail and DoubleLine have filed for does not have Jeffery Gundlach’s name behind it. Given that emerging market bond strategy is the only one within DoubleLine that is not currently lead by Jeffery Gundlach provides the hint that even DoubleLine wants to evaluate the success of their first product before putting its star manager behind a new Active ETF. If the modification in structure proposed by iShares comes to pass, that would definitely go a long way towards providing confidence to star managers that their investment know-how and trading strategies will not be “given away” at the end of each day.

SEC’s Concern

The head of SEC’s investment-management arm, Andrew Donohue, mentioned in the Bloomberg piece that he was primarily concerned about disrupting the process that “keeps a fund’s per-share net asset value and share price closely aligned”. This is a genuine concern because if fund disclosure was to happen less frequently, then the market maker who has the responsibility of arbitraging to keep the ETF price close to NAV will have difficulty in doing that effectively. Without knowledge of what the fund’s holdings were on the previous day, the creation/redemption process – the means by which the arbitrage process occurs – will likely be hampered as the market maker would be operating with a stale view of the fund’s composition.

Learning From Neighbours?

As was proposed in this article, a good idea might be to pick up a few regulatory insights from other countries and how they regulate actively-managed ETFs. In Canada, Active ETFs are not required to provide daily disclosure of holdings. In fact, the leading provider of these products in Canada, Horizons AlphaPro, discloses holdings only once a month, which is still better than most mutual funds. However, they provide complete disclosure of the fund to the ETF’s market makers so that they have all the information they need to make markets and minimize the discount/premium of the ETF share price from NAV. So that’s a framework worth considering by the SEC – providing complete but confidential disclosure of the fund holdings to the market maker or AP on a daily basis while providing public disclosure with a lower frequency in order to safeguard the manager’s value proposition.

Fundamental Difference

Looking at the bigger picture, there is a fundamental difference in how actively-managed ETFs have been evaluated by regulatory bodies in the US versus those in Canada that has resulted in the policy requirements for each. In the US, Active ETFs have been seen as “ETFs” first and actively-managed funds second. Hence, the US requirement to provide daily disclosure of holdings as is the norm for all other ETFs. In Canada, they are considered first to be actively-managed funds and are thus regulated in much the same way that active mutual funds are regulated in Canada.

How this debate plays out will be very interesting to see and the approach that the SEC takes to regulate actively-managed ETFs in the US will likely have huge ramifications on the attractiveness of these products to issuers and renowned active managers. BlackRock iShares, being the biggest ETF issuer, has already lead the way in bringing up the issue with the SEC. If the SEC decides to address these concerns, it could be a big win for the Active ETF issuers.

Disclosure: No positions in above-mentioned names.

Grail Advisors Files For Emerging Markets Fixed Income Active ETF

Shishir Nigam — Wed, 23 Jun 2010 21:26:11 +0000

On June 23^rd, Grail Advisors filed a preliminary prospectus with the SEC for a new actively-managed ETF called the Grail DoubleLine Emerging Markets Fixed Income ETF which will be listed on the NYSE once approved and brought to market.

The fund will look to maximize current income and obtain capital appreciation by investing in US$ denominated debt securities issued by companies or institutions in at least 4 different emerging markets. This strategy is a first in the actively-managed ETF space as most existing strategies within these products are US focused and have largely been equity-based. The portfolio’s duration will be between 2-8 years. The fund will be sub-advised by DoubleLine Capital LP’s portfolio manager, Luz M. Padilla, who will be responsible to the day-to-day investment decisions for the portfolio. Luz is the manager behind the firm’s existing DoubleLine Emerging Markets Fixed Income Fund (DBLEX), which was just launched in April 2010. DoubleLine itself was only founded in 2009.

The preliminary prospectus did not disclose details on the expense structure for this proposed ETF but did indicated that the net annual operating expenses will be 0.95%. Interestingly, the portfolio may also invest up to 20% of its assets in defaulted corporate securities where the manager believes the restructured company will be worth significantly more than current valuations. Whether that strategy turns out to be more of a risk enhancer than a return enhancer remains to be seen. To ensure diversification, the fund managers cannot invest more than 25% of the portfolio is any one emerging market. And as with all actively-managed ETFs, the fund will disclose the holdings of the portfolio with a 1-day lag to ensure transparency of the portfolio. The filing did not specify a benchmark against which performance would be measured.

This filing comes just as AdvisorShares, a competitor of Grail Advisors, announced yet another partnership with its 6^th external asset manager. Grail Advisors now has partnerships with 4 different managers but Grail has many products that are already trading on the market, with seven actively-managed ETFs available for trading. The other 3 sub-advisors that Grail partners with include American Beacon, RiverPark and McDonnell.

Disclosure: No positions in above-mentioned names.