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Actively-managed ETFs are now close to completing the 3^rd year of their existence. The oldest active ETFs on the market, a set of four funds that Invesco PowerShares launched in April 2008, will reach their 3^rd anniversary on April 11^th, 2011.

Growth within the active ETF space has been solid but most observers would agree that it hasn’t been spectacular. Active ETFs in the US had combined assets of just $2.1 billion at the end of June 2010 and that number had grown by more than 65% to $3.5 billion at the end of Feb 2011. Of course, large percentage increases don’t mean much when the absolute sums we are talking about are so small. Active ETF assets are still only a drop in the ocean that is the trillion dollar US ETF market.

There are some definite hurdles that continue to hinder the active ETF space and prevent the sort of exponential asset growth that has become commonplace in other ETF segments. Some of these are hurdles that are faced by issuers, others that are faced by investors and some that neither issuers nor investors can do anything about.

Hurdle #1 – The SEC

As you might have guessed, the hurdle that no one can really do anything about comes from a regulatory source. In order to launch actively-managed ETFs for the first time, fund companies need to file an application with the SEC requesting exemptive relief necessary to create an ETF. Once that relief has been granted, the issuer can then file a prospectus for the specific planned ETF and move ahead with product launches under the granted relief order.

There has been no lack of exemptive relief applications filed with the SEC for the launch of actively-managed ETFs. Numerous large fund managers, including the likes of Eaton Vance, J.P. Morgan, Legg Mason, T. Rowe Price and others, have active applications with the SEC for proposed active ETFs. However, in early 2010, the SEC launched a review of derivatives usage within ETFs and announced that all exemptive relief applications for active ETFs will be put on hold while this review is conducted.

This effective freeze set back product developments for many of these issuers by many months, if not years. For example, a case in point is Van Eck which was finally granted relief by the SEC in Nov 2010, after waiting a whole two years, having first put in their exemptive relief application in Nov 2008. Many firms started removing derivative usage from their planned funds to avoid trouble with the SEC, while others such as Russell took a more aggressive approach by acquiring a company that had already been granted relief.

According to IndexUniverse, the last word on the progress of this investigation came in the summer of 2010, when the SEC voiced concern to the IFIC regarding the generic nature of derivative disclosures in fund prospectuses. When the review finishes is anyone’s guess but the investigation has definitely created a regulatory overhang over the active ETF space and that is definitely not helping product development plans.

Hurdle #2 – Transparency Requirements

Transparency has traditionally been considered an advantage when looking at index ETFs versus mutual funds. However, when that transparency requirement was extended out to active ETFs, it became a whole new issue.

Active ETFs in the US are required to disclose their complete holdings with a 1-day lag. This means that that general public will have knowledge each morning of every single security that the portfolio held, as of the prior day’s close. So you could say that the disclosure is not “real-time”, but it’s close enough to cause active managers the jitters. There are some active managers behind active ETFs who are perfectly comfortable with the transparency requirements, as David O’Leary – the portfolio manager behind the oldest active ETF – mentioned to us in this interview. However, there are others who firmly believe that the high level of transparency is deterring some active managers from running active ETFs.

There are two key concerns when it comes to transparency. First off, active managers who are used to making quarterly disclosures when running mutual funds find it hard to digest why they should give away their alpha-generating strategies and ideas to everyone including their competition. By making daily disclosures, the fund managers effectively telegraph the moves they make every day and potential “copy-cats” could just follow along without having to pay the management fees. The second major concern is with regards to front-running. If a portfolio manager intends to build up a significant position in an illiquid security, they often have to do it over several trading days so as not to “move the market”. However, if during their multi-day trading program, outsiders can see which positions are being added to or reduced, they could potentially front-run the pending trades of the portfolio manager.

Some attempts are now being made to address these concerns through the development of a non-transparent active ETF structure that would not require daily disclosures while still enabling market makers to ensure that the ETF share price is kept close to the fund NAV. However, looking at how long it is taking the SEC to approve applications for even traditional, transparent active ETFs, adoption of this new structure might still be a fair distance off.

Hurdle #3 – ETF Adoption In Retirement Plans

Most retirement and 401(k) plans continue to offer only mutual funds to investors, thereby creating a clear obstacle to ETFs in general, not just active ETFs. Part of this has to do with inertia amongst investors while another part is just logistics.

Investors are used to and understand mutual funds well. They are simple and easy to understand investment vehicles that many are comfortable with. Even though ETFs have now been around for a decade, they are still a relatively new investment vehicle in the eyes of many. Active ETFs specifically are even more novel, though one could argue that they are more like your traditional mutual fund than index ETFs would be. In this regard, investor education remains paramount as investors have to understand the benefits of the ETF structure over mutual funds before they can make a conscious choice. The other part of this obstacle is in fact operational. Many plan administrators are just not equipped to handle ETFs. For example, mutual funds settle in a T+1 basis, whereas ETFs, like stocks, settle on a T+3 basis. This basic difference in itself creates an operational challenge for plan administrators.

However, this is one hurdle where some progress is being made. In recent years, there have been several launches of “ETF-only” 401(k) plans that only utilize ETFs in implementing portfolio strategies. In fact, Schwab just recently launched an ETF-only 401(k) plan to take advantage of the benefits that ETFs have to offer. Advisors themselves are moving away from a commission-based structure where they get paid a trailer fees from the mutual funds that they sell.

Once this train gets moving, that’s when active ETFs will have a real chance of kick-starting widespread adoption because whether in an ETF or a mutual fund, investors will still continue to look for actively-managed strategies.

In an interview with Forbes, Jason Huntley – CIO of Mars Hill Global Relative Value Fund, spoke about the what Active ETFs are, how they compare with passive ETFs, what it’ll take for them to take off and how ETFs are “bought” while mutual funds have always been “sold”. Mars Hill is the sub-advisor to a recently launched actively-managed ETF from AdvisorShares, the Mars Hill Global Relative Value ETF (GRV: 24.58 0.00%) which was the first long-short equity ETF on the market. GRV has been quite successful relative to other Active ETF launches as the fund gathered more than $40 million in assets in quick time to become the largest actively-managed equity ETF in the US.

Jason Huntley describes where actively-managed ETFs fit in and how they compare to mutual funds and passive ETFs. In essence, these structures are most closely aligned with active mutual funds, in terms of the strategy followed by the portfolio manager, in that the PMs make active security selection decisions in the portfolio and are not obligated to track an index. The big difference though is that Active ETFs bring the benefits of the ETF structure – tax efficiency, daily portfolio transparency, real-time liquidity – and combines them with the potential for active management.

When asked why these ETFs haven’t taken off, Huntley focused on the education process necessary to highlight the benefits of Active ETFs to two key groups. Firstly, active managers who might be running mutual funds or separate accounts need to be educated more on the benefits of the ETF package over pooled accounts as a vehicle or wrapper for their strategy. Secondly, the investors themselves need to be educated, with ETF usage still in its infancy amongst retail investors.

A final interesting point that Huntley raises is that mutual funds typically have been “sold” to investors by brokers or financial advisors who are getting paid a commission to sell those funds. ETFs though are “bought” since there is no commission structure for brokers selling the ETF. That is of course one of the main things that makes the inertia of advisors who are used to selling mutual funds, harder to overcome.

As President Obama continues to place an importance on energy efficiency and lowering carbon emissions, demand for electric vehicles is expected to spike paving the path to prosperity for the First Trust Smart Grid Infrastructure ETF (GRID), the Utilities Select Sector SPDR (XLU) and the Global X Lithium ETF (LIT).

The National Highway Safety Commission forecast that nearly 20% of all automobiles in the US will be running on some sort of a hybrid mechanism by 2015.  Furthermore, Aaron Levitt of Investopedia states that the U.S. has committed $2 billion in Recovery Act spending for advanced batteries production and nearly $25 billion for programs to promote car makers to retool their production lines for production of more fuel-efficient vehicles. 

As a result, many carmakers are starting to make changes to their lineups and offer these hybrid vehicles.  The most recent change came from General Motors as it announced the upcoming release of the Chevrolet Volt, which is an electric vehicle that runs on a battery and electricity generated from a gas-generator.  Additionally, German automaker Volkswagen plans on releasing all-electric within the next year or two. 

This phenomenon of electric vehicles has already been somewhat of a hit with consumers, illustrated by the performance of Tesla Motors (TSLA), which has witnessed insatiable demand for its Tesla Roadster.  As a result, Tesla expects to start production of a five-seat family sedan next year to tailor to expand its lineup.

At the end of the day, as governments continue to push for cleaner energy and lower carbon emissions, electric vehicles are expected to gain popularity giving support to the aforementioned ETFs.

• First Trust Smart Grid Infrastructure ETF (GRID) is bound to reap the benefits of the infrastructure improvements and developments that will be required to sustain an electric cat movement, such as new transmission lines, power plants and charging stations.
• the Utilities Select Sector SPDR (XLU), which will likely reap the benefits of increased electricity consumption
• the Global X Lithium ETF (LIT), which will likely reap the benefits of increased demand of lithium-ion batteries, which are essential in electric and hybrid vehicles

Disclosure: No Positions

Read more here:
Three ETFs To Play Electric Vehicles

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As economies in Asia continue to prosper, the demand for air travel is following putting the Guggenheim Airline ETF (FAA) in a position to potentially reap the benefits. 

According to aviation forecaster Ascend Worldwide, Asia-Pacific region airline carriers have ordered 133 commercial jets so far this year, comprising 23 percent of all new orders globally, with Cathay Pacific Airways, Qantas Airways and Emirates Airline awaiting delivery of about 400 planes.  Furthermore, the number of new orders globally is expected to nearly double over the next twenty years to combat a shortage in both cargo and large passenger fleet, driven primarily by Asia-Pacific in the near term. 

The purchasing power of consumers in the Asia-Pacific region has increased significantly over the past five years and is expected to continue to trend upward making airline travel that much more affordable in the region.  Both China and India have witnessed purchasing power more than double over the past ten years and are expected to continue to see this growth over the next ten years, which in turn has lead to increased consumer spending and will likely lead to increased demand in airline travel.

As previously mentioned, one way to play the global airline sector is through the Guggenheim Airline ETF (FAA).  Although FAA is heavily concentrated with US based airlines (US accounts for more than 70 percent of its county weighting), it does give some exposure to Singapore Airlines, Qantas, Cathay Pacific Airways and Korean Air Lines.

Disclosure: No Positions

Read more here:
Increased Air Demand In Asia May Boost Airline ETF

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