Credit: Shutterstock photoThe influx of capital into exchange-traded funds has prompted many active managers to take a hard look at their business models. The old days of high-fee mutual funds, hedge funds, and separate accounts are becoming harder to justify. Investors want transparency, they want liquidity, and they want low-cost.
Those are the hallmarks of the exchange-traded fund platform. It’s why companies like BlackRock and Vanguard have expanded their asset management businesses by hundreds of billions of dollars over the last several years. This is a freight train of capital moving in virtually one direction with no signs of slowing down.
Many of the active managers have realized that it’s difficult to fight this trend and are now adopting their own investment strategies to the ETF space. Releasing a few funds to replicate an existing line of business or slow the flow of capital from heading out the doors.
For select fixed-income shops like PIMCO and DoubleLine, this has proven to be a sound tactic. They offer modestly cheaper versions of their existing strategies and the money has remained loyal. There is currently $7 billion in the PIMCO Enhanced Short Maturity Active ETF (MINT) and $3.5 billion in the SPDR DoubleLine Total Return Tactical ETF (TOTL) to name a few. Both firms have several other successful actively managed ETFs as well.
Conversely, the larger equity managers have not found a way to crack this code. There are a few with modest asset levels such as the AdvisorShares Wilshire Buyback ETF (TTFS) and Cambria Shareholder Yield ETF (SYLD). Most investors who own these funds are likely doing so because they believe in the sound research and largely systemic portfolio screening that the managers are known for. Those factors can cause one to overlook the modestly higher fees than you would pay for a typical low-cost index fund.
The group that is the most out-of-step with the true spirit of exchange-traded funds are the active stock pickers. The ones that are attempting to own a small basket of handpicked equities to beat a broader index and charge a comparatively high fee in the process.
For example, ETF.com recently reported that Spinnaker Trust is rolling out the actively managed Fieldstone Merlin Dynamic Large Cap Growth ETF (FMDG). According to their notes, “It invests in companies that are described as ‘similar’ to those in the Russell 1000 Growth Index, selecting 25 securities that the subadvisor expects will exhibit greater return on equity and earnings growth than their peers.” FMDG will charge an expense ratio of 0.80% annually.
This one is a head scratcher for me. The Russell 1000 Growth Index has over 500 stocks in it, yet the manager of FMDG is expecting to pick just 25 companies with similar market cap characteristics. That concentrated portfolio will largely mitigate the diversification benefits that ETFs are touted for and create a far different return profile than the benchmark. It will likely have some years that will outperform and others that will underperform.
Furthermore, at an expense ratio of 0.80%, this active ETF is over six times more expensive than the 0.12% management fee of the Vanguard Russell 1000 Growth ETF (VONG). That’s a hefty premium to pay for research and security selection.
There is largely no way to predict how the manager will react to changing market circumstances or a poor stock choice either. One of the best things about a passive ETF is that you know exactly what it owns, what it costs, and what timing or other factors would prompt a rebalancing of its holdings.
The Bottom Line
I understand the high costs associated with launching an ETF and the ongoing monthly obligations regardless of size. Not everyone can charge 0.10% expense ratios like the mega firms that benefit from their tremendous scale. Nevertheless, there is likely a better compromise of costs and value that can be struck to create wider adoption of these active funds in the stock picking category.
Disclosure: At the time this article was written, the author and clients of FMD Capital Management owned shares of TOTL.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
