07 February 2008

US Regulators give green light to active ETFs

US regulators have granted tentative approval for three fund providers to begin offering actively managed exchange traded funds as the mutual fund industry awaits the expected entrance of the controversial new type of investment vehicle.

ETFs, which like stocks can be bought and sold throughout trading days on public exchanges, typically track an index passively through a basket of securities and cannot choose other individual investments. 

But last Friday the Securities and Exchange Commission exempted Invesco’s Powershares Capital Management from rules that prevent ETFs from making trades.  

Pending a public review process set to expire on February 26, Powershares will be able to start offering actively managed ETFs by the end of the month.   

On Tuesday the SEC issued a similar ruling for Bear Sterns Asset Management and yesterday did the same for Barclays Global Investors. 

One of the regulatory dilemmas was that most passive ETFs disclose their holdings publicly each day.  This is not a problem when the funds are simply tracking an index.  But if fund providers were to disclose the holdings for actively managed funds that trade frequently, investors could try to front-run, or get ahead of, the trades. 

Among the solutions worked out between between Powershares and the SEC is to restrict the number of trades a single fund can make each week. The fund must also execute all the trades on the same day.  Funds will have to disclose their holdings online before the start of trading each morning.

Stuart Strauss, a partner at law firm Clifford Chance that represented Powershares, said in a statement: “The exemption will allow an ETF to pursue active investment strategies. We have been working with the SEC for a long period on actively-managed ETFs to promote the resolution of the evolving regulatory issues associated with these kinds of funds.” 

Investors have more than $600bn (€411bn) in US-listed ETFs, according to State Street.  Money invested in them grew by 45% last year, as 270 new funds were introduced.

Many analysts and observers have questioned the wisdom of actively managed ETFs, arguing they will be costlier and less efficient than traditional ETFs, resembling active mutual funds.  Tom Lydon, editor of the newsletter ETF Trends, said: “It’s going to be interesting to see what their expense ratios look like, but my thoughts are that [active ETFs] might hit the market with a great big thud.” 

Lydon added: “The benefits of ETFs are their low costs and especially their transparency.  A lot of hedge funds and institutions invest in ETFs because they’re liquid and efficient.  On the other hand, when these institutions invest in mutual funds, they choose managers with a track record.  But managers of actively managed ETFs won’t have track records and past performance on which to judge them.”

Cardiff de Alejo Garcia, Financial News

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