Columbia to dump Grail's subadvisers after acquisition

Columbia Management Investment Advisers, LLC, a subsidiary of Ameriprise Financial Inc, has agreed to purchase Grail Advisors LLC, a move that could transform the firm into a major player in the active exchange-traded fund industry, experts said. As first reported on InvestmentNews.com yesterday, Ameriprise had been in talks with Grail and a deal had been imminent. By purchasing Grail, Columbia will automatically have exemptive relief from the SEC to launch actively managed ETFs, which can often take months, if not years to get. “We have been looking at the industry and clearly active ETFs are a newer addition to the market, but they certainly make sense for a number of different kinds of investors,” said Christopher Thompson, head of product and marketing at Columbia. “Our strategy is to make sure that we are offering many different ways to do business with us whether that's through mutual funds, separately managed accounts, collective trusts, and now actively-managed exchange-traded funds.” Columbia is replacing the subadvisers of Grail's five ETFs with its own managers as a first step, but ultimately hopes to have a whole line of active ETFs, Mr. Thompson said. Specifically, the firm is replacing American Beacon Advisors, Inc., RiverPark Advisors LLC, Wedgewood Partners Inc., McDonnell Investment Management, LLC and Western Asset Management Co. with its own managers. The new managers will be in place by end of May, Mr. Thompson said. He declined to comment on what kinds of ETFs the firm will launch going forward, but did note that there will be “significant overlap,” with the firm's mutual funds. “That's not to say there will be exact clones of mutual funds,” he said. Ultimately, Columbia could even convert some funds to ETFs, said Scott Burns, an analyst at Morningstar. That capability, along with the fact that Ameriprise offer model portfolios of ETFs already and has 11,482 advisers could make Columbia “a big player,” in active ETFs, he said. “They have the asset management platform, and they have the broker-dealer platform,” Mr. Burns said. “If they have the wherewithal this could be a serious offering.” Columbia has no immediate plans to convert funds into ETFs, but wouldn't rule it out, Mr. Thompson said. There are a number of challenges facing Columbia. First of which is that it remains to be seen how the firm will avoid having its mutual fund managers' trades be front-run by hedge funds if these portfolios are available as ETFs, which are completely transparent. This transparency issue has caused a number of mutual fund companies to hold off getting into the active ETF space. “We are looking at the issue and at the trading patterns of each manager,” Mr. Thompson said. “We don't see it as being an issue.” Some industry experts wonder if launching active ETFs can help attract advisers' attention to Columbia. Overall, the firm's fund performance has been average, with some exceptions, said David Kathman, an analyst at Morningstar Inc. As of March 31, 19.68% of the firm's equity funds and 21% of its fixed income have been in the top quartile of their peers for the past three years; while 25.77% of its equity funds and 17.28% have been in the top quartile for the past five years and 29.29% of its equity funds and 9.65% of its fixed income funds have been in the top quartile for the past 10 years, according to Morningstar. “Anything with ETF in the name is pretty hot now so that should get advisers' attention,” said Tom Roseen, a senior analyst at Lipper. “A key question will be what will the costs of the ETFs be and will they be the same as the open-end mutual funds.” Columbia said it is still figuring out the pricing structure of the ETFs. “Columbia's funds have seen strong performance lately,” Mr. Thompson said. Fifty two of the firm's 120 funds have four or five star ratings from Morningstar, according to the firm. Being able to offer its own ETFs, which are completely transparent in their costs and don't offer advisers any type of commission, would be welcome to Columbia's parent, Ameriprise and its advisers, given the firm's difficulties over the past several months, observers said. Ameriprise and its Securities America Inc. subsidiary have been steeped in litigation over the past several months by investors who were burned by Reg D offerings that flamed out. This week, the firms reached a proposed $180 million agreement with clients who bought $400 million of these high-risk offerings that went bust. The agreement is slated to be submitted to a federal judge within a week. “The fact that ETFs offer advisers no commissions will be a good thing for Ameriprise's image,” said Sophie Schmitt, a senior analyst at Aite Group. “ETFs are transparent, [offering active ETFs] would be a way for the firm to differentiate itself from its competitors.” One of the challenges that Ameriprise has wrestled with over the years is the image that they are pushing their own product, Ms. Schmitt said. “Since ETFs have no commission, that might lessen the challenge for advisers,” she said. Particularly with the upcoming fiduciary standard and other regulations coming down the pike, being able to offer actively managed ETFs, which assumingly will cost less than mutual funds, would be attractive, said David G. Miller, an adviser with Miller & Associates, an Ameriprise franchise. “As more regulations come about and there are more discussions about the internal costs of products, this simplifies those issues and reduces the costs, which is always attractive to clients,” he said. But integrating an ETF business into a traditional asset management firm can prove challenging, said Matt Hougan, president of ETF analytics at IndexUniverse.com For example, when Invesco Ltd. bought Powershares Capital Management LLC, it required some doing for the firm to get the sales force to sell the ETFs aggressively, he said. “It takes time for people who are used to selling mutual funds to adapt to the ETF market where it's very hard to compensate the sales force and there is no direct link to who bought what,” Mr. Hougan said. “The question is, will those Ameriprise financial advisers have an incentive to distribute lower-cost ETFs as opposed to higher profit mutual funds?” In addition, Columbia is entering a market that has been slow to take off. There are currently only $4 billion in active ETFs, compared to over $1 trillion in the entire ETF industry. As evidenced by Grail's troubles, it remains to be seen if there is demand for actively managed ETFs, experts said. Grail, which launched its first actively managed ETF in May 2009, closed two of its ETFS in August: Grail RP Financials and Grail RP Technology. The firm has five funds with a total of $23 million in assets. But just over the past few weeks, BlackRock Inc. and Eaton Vance Corp. have received exemptive relief from the SEC to launch active ETFs.