Flurry of active ETFs expected this year

After waiting for months and in some cases years, fund companies are starting to see progress on their applications to launch actively managed exchange-traded funds, according to several fund executives. This development, along with a number of key acquisitions during the past few months, has industry observers predicting that there will be a flurry of active ETFs brought to market this year. But whether these funds garner significant assets remains to be seen. Actively managed ETFs, for the most part, have struggled to attract assets since they first came to market three years ago. There are 19 actively managed ETFs with a total of $1.23 billion in assets (not including currency ETFs), compared with passively managed ETFs, which have more than $1 trillion in assets, according to Morningstar Inc. One barrier for actively managed ETFs is that the Securities and Exchange Commission has been slow to grant exemptive relief to companies that have applied to launch such funds. A number of firms, such as The Dreyfus Corp., Eaton Vance Investment Managers and T. Rowe Price Group Inc., sought permission to start actively managed ETFs. Last March, the SEC said that it was reviewing whether additional investor protections were needed related to the use of derivatives by mutual funds, ETFs and other types of investments. As part of the review, the SEC said that it wouldn't approve any active ETFs using derivatives until its examinations were complete.

AMENDED FILINGS

But over the past few months, fund executives said that the SEC has been working with them so that they can get their applications approved. AdvisorShares Investments LLC, Guggenheim Investment Advisors LLC, T. Rowe Price and Van Eck Global all have amended their filings to say that they won't use derivatives in their portfolios. “The proof that things are going forward can be seen in how people are amending their filings,” said Scott Burns, an analyst at Morningstar. The SEC has spent the past several months getting a better understanding of how active ETFs work and seems more comfortable with approving these offerings, said one executive, who works at a company that has been in talks with the commission about its application to launch active ETFs, and asked not to be identified. “The SEC is finally catching up on the backlog of work that they had to step away from due to the flash crash,” said another executive, who works at an asset manager that has filed for exemptive relief, and asked not to be identified. “We are going to see more active-ETF launches in 2011.” John Nester, an SEC spokesman, declined to comment. Industry experts also point to a few recent acquisitions and pending acquisitions as factors that could prompt more active-ETF launches this year. In a Jan. 5 filing with the SEC, Grail Advisors LLC, a provider of active ETFs, disclosed that it had signed a letter of intent to sell the firm. And if a firm with deep pockets buys Grail, it could mean more product launches and a boon for the industry, said Noah Hamman, chief executive of AdvisorShares Investments LLC, an active-ETF provider. Also last month, Russell Investment Management Co., which filed in 2009 to launch active ETFs, said that it is acquiring U.S. One Inc., which has one actively managed ETF. As a result of the acquisition, Russell has the ability to launch actively managed ETFs, and observers predict that the firm will come out with an array of both passive and active ETFs in the coming months.

EATON VANCE'S PURCHASE

But the acquisition that observers said could have the most significant implications for active ETFs occurred last year when Eaton Vance acquired the assets of Managed ETFs LLC, a developer of intellectual property designed to establish non-transparent ETFs. With the purchase, Eaton Vance — once it gets SEC approval — will be able to launch actively managed ETFs without having to disclose its portfolio holdings on a real-time basis. Such disclosure of portfolio holdings, which is required of all ETFs, has caused many asset managers to be skeptical about their value, but this could address that issue, observers said. “Actively managed ETFs will only be fully developed if there is some solution to this transparency issue,” said Thomas E. Faust Jr., chief executive of Eaton Vance. But launching non-transparent active ETFs is still a ways away for the firm, as the SEC needs to approve the concept first, he said. Yet another development that could jump-start the active-ETF space is if Huntington Asset Advisors Inc. gets approval from the SEC to convert a mutual fund into an ETF, which would make it the first firm to do so. On June 17, Huntington, the investment arm of Huntington Bancshares Inc., filed a request with the SEC to launch two actively managed ETFs. They are the Huntington Ecological Strategy Fund, which will follow environmental themes, and the Huntington Rotating Strategy Fund, an ETF version of its Huntington Rotating Markets Fund (HRIAX). The fund seeks to shift holdings among various equity market segments where the firm sees fit. Once the rotating-markets ETF is up and running, Huntington plans to fold in the existing mutual fund that follows that strategy, said Randy Bateman, Huntington's president and chief investment officer. Huntington recently received word that the firm's order for exemptive relief is making its way through the SEC, he said. “If Huntington gets approval to do a conversion, it won't just prompt other firms to do the same thing, but it will speed up the asset gathering in the active-ETF space,” Mr. Burns said. Apart from that, there isn't a lot of evidence that 2011 will be the year that active ETFs see huge growth, he said. Even with the first actively managed ETFs — which are managed by Invesco Powershares Capital Management LLC — approaching their three-year anniversary in April, Mr. Burns doesn't anticipate a big jump in assets. “Once those funds hit the three-year mark, they will get star ratings from Morningstar, and that might help garner assets,” he said. “But it depends on the ratings.” E-mail Jessica Toonkel at jtoonkel@investmentnews.com.