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Almost all the things you don't like about mutual funds have been fixed in a new investing product called the actively managed exchange-traded fund.
Wait a moment – aren't ETFs the anti-mutual fund?
Yes, to many investors they're just that thanks to their mandate to track stock and bond indexes rather than trying to out-guess the market by choosing individual securities. But now there's a different type of ETF – one that does exactly what conventional mutual funds do, but without the high cost and impediments to convenient buying and selling.
Actively managed ETFs were introduced in Canada by Horizons AlphaPro in early 2009 and the reception was unenthusiastic. I wrote a column dissing them on the basis that many fund managers can't beat their benchmark indexes, a point that highlights the benefit of the traditional index-tracking ETF.
The actively managed ETF market has evolved in 2010, and so has my view. With some quality managers being recruited to run these ETFs, I think they have the potential to be one of the most significant retail investing developments in years.
To understand why, take a look at the HAP North American Value, Dividend and Managed S&P/TSX 60 ETFs. The value ETF is run by Vito Maida, whose safety-first approach to investing in stocks has until recently been available only to high-net-worth investors. Managing the dividend ETF is Lyle Stein, a fund industry veteran who now runs the venerable investment firm Leon Frazer & Associates. The managed S&P/TSX 60 fund is run by a team from Front Street Investment Management that includes Frank Mersch, a mutual fund industry star in his days at Altamira Investment Services.
“These guys are different in how they do things,” said fund analyst Dan Hallett of HighView Financial Group. “But all three are quite good.”
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Subpar managers are easy to find in the mutual fund world – that's precisely why conventional index-tracking ETFs have become such a fast-growing product. But savvy investors know there are some managers who are worth putting to work in your portfolio. Actively managed ETFs are a smarter way to access these managers.
Ken McCord, president of AlphaPro Management, summed up the benefits of actively managed ETFs as follows: “Lower fees, they're way more convenient and they're way more flexible.”
Let's start with fees. The management expense ratios for five of the AlphaPro active ETFs is 1 per cent, while two others come in around 1.25 per cent. In addition, performance fees are charged if the funds beat specific benchmarks.
You can buy core index-tracking ETFs with MERs of 0.17 to 0.6 per cent or so, but mutual funds can easily charge 2 to 2.4 per cent. Although he's a little leery of the impact that performance fees could have, Mr. Hallett calls AlphaPro's pricing a fair deal.
“It's kind of hard to get a lot lower than that and make it worthwhile for the manager,” he said.
A major reason why active ETFs cost less to own than mutual funds is that their fees do not include a component that is intended to compensate investment advisers for the counsel they provide clients. This so-called trailing commission accounts for one percentage point of the typical equity fund's MER and 0.5 points for the average bond fund.
For do-it-yourself investors, actively managed ETFs are a revelation. The reason is that DIY types that own mutual funds face the same MERs as investors using advisers, even though there's no advice to justify the trailing commissions.
Fund companies actually offer a special version of their funds, called F-class, with trailing commissions stripped out. But they're strictly for fee-based advisers who charge separately for their services and off limits to do-it-yourself investors. No wonder DIY types are often so scathingly critical of mutual funds.
