Thursday, November 19, 2009

Managed Exchange Traded Funds?

Whatever happened to the actively managed mutual fund vs. the passive index or sector exchange traded fund (ETF) battle?

Several years ago investors began to flee active mutual fund managers because for the most part, they failed to match the performance of their benchmark index or stock sector. The investment industry responded with cheaper passive ETFs that tracked the performance of the major stock indices (index funds) and sectors such as Financials, Energy, Materials and so on. Now the manufactures of ETFs have a problem – there are just too many – too much competition and so they have invented a new product – the actively managed ETF. So now we go full circle – from actively managed mutual funds to passive ETFs and now back to actively managed ETFs.

One of the original active ETF entries was PowerShares FTSE RAFI US 1000 Portfolio (NYSE:PRF) which seeks investment results that correspond generally to the price and yield of an equity index called the FTSE Research Affiliates Fundamentals US 1000 Index. The Index is designed to track the performance of the largest United States equities, selected based on four fundamental measures of firm size: book value, cash flow, sales and dividends. The 1000 equities with the highest fundamental strength are weighted by their fundamental scores

Here is the shocker – on November 18, 2009 -- Research Affiliates LLC announced that the United States Patent and Trademark Office has approved the issuance of U.S. Patent No. 7620577 for the company's innovative Research Affiliates Fundamental Index® ("RAFI®") indexing methodology, which selects and weights securities using fundamental metrics of company size rather than by market capitalization.

In other words a large cap value fund has a patented managed methodology – all very stimulating because if the methodology is patented - it must be good. Right? Well, let me now compare the “patented” managed fund to another large cap value fund, its called the Dow Jones Industrial Average, a basket of America’s biggest value companies – most of them multinationals. The best way to compare the difference is to use a simple spread or ratio chart. The inception of the fund is December 2005 and the Dow (now over 100 years old) recently had two components vaporized in the 2008 financial crisis. Our simple spread clearly the passive Dow out performed the managed ETF through 2006, 2007 and 2008 with the ETF posting an out perform only from March 2009 to October 2009.

The other problem with the managed ETFs is their poor liquidity and low volume. For example at the close of November 19 the PRF was bid 46.67 and ask 47.80 with total volume 28,240 The competing Diamonds Trust (NYSE:DIA) was bid 103.63 and ask 103.77 with total volume 12,739,200

Now if anyone out there knows of a managed ETF that works I am all ears

2 comments:

300m said...

Bill
This should be interesting
Toronto, Ontario – November 18, 2009 – Jovian Capital Corporation (“Jovian”) (JOV: TSX) and its subsidiary AlphaPro Management Inc. (“AlphaPro”) are pleased to announce the launch of the Horizons AlphaPro Seasonal Rotation ETF (the “ETF”)

Sean said...

The liquidity on these is "hidden" and is actually deeper than the posted bid and ask. Market makers can create and destroy units if there is an arb. Right now the spread is 5c and there are 10,000 on the bid and the offer. You were looking at the spread after the close when the arbs had gone home.