Having talked about all these concerns, it’s important to see that there are 32 actively-managed ETFs now listed in the US, according to the Active ETFs Database. Each of these funds has launched and is operating successfully with the daily disclosure requirement in place. So how are some of these funds dealing with the issue?

1. Utilizing A Fund-of-Funds Approach

One of the ways that managers behind Active ETFs have dealt with this is by utilizing a fund-of-funds approach and investing exclusively through ETFs, instead of individual securities. Funds such as the AdvisorShares’ Dent Tactical (NYSEArca: DENT) and Mars Hill Global Relative Value (NYSEArca: GRV) use this approach. Each of these funds discloses all the underlying ETFs that they hold from day to day. It is much harder for a trader to benefit from front-running trades in ETFs than in individual securities. This is because the value of the underlying ETF shares, unlike individual stocks and bonds, is not dependent of the supply and demand of the ETF shares, but instead on the underlying securities of that ETF. As such, the price of that underlying ETF will not be affected significantly if someone traded a large block of shares in the ETF just before the portfolio manager. Also, the managers generally utilize high volume ETFs which makes any one market player insignificant relative to the total activity in that ETF.

2. Utilizing Market-on-Close (MOC) Trading

Another method used by managers to reduce the market impact of completing trades in a day is to utilize the higher liquidity available at market-on-close, instead of trading intraday. AER Advisors, which is the sub-advisor to two PowerShares’ Active ETFs – Active AlphaQ (NYSEArca: PQY) and Active Alpha Multi-Cap (NYSEArca: PQZ) utilizes this approach by focusing all their trades at MOC instead of trading throughout the day. This means that the portfolio manager receives whatever the closing price is for their orders and also benefits from the liquidity which is usually much higher at MOC.David O’Leary, CIO at AER Advisors, spoke to us recently as well, and explained, “In our case, we’re doing market on close and I’ve found that small changes in the portfolio are much better than continually trading during the day”. O’Leary has been managing PQY and PQZ since April 2008 and added that he no longer has concerns resulting from the transparency of the portfolio, even though he believes the potential for front-running still exists. “I was concerned about the transparency issue but having been managing it for a couple of years now, I really am not concerned about it at all”, said O’Leary.

3. ETF Convenience Justifies Expense

When it comes to investors copying the entire portfolio to avoid the management fee, there are those managers who believe that is just not cost effective for investors to replicate the portfolio and “follow along”. Paul Hrabal, President CIO of U.S. One, and also the portfolio manager behind One Fund (NYSEArca: ONEF) mentioned this in an interview, saying that “If you think about it, if you have 5 ETFs and you’re going to rebalance it and you’re going to put in new money maybe 4 times a year, to make those incremental trades for 5 different ETFs, depending on where your brokerage account is, could end up being much more costly than paying us the 35 basis points. Consider a $10,000 investor, they’re going to pay us $35 a year extra to do it for them versus doing it themselves. In most people’s view, that’s not going to be enough of a cost that they’re going to want to do it themselves”.

In fact, Hrabal encourages investors who’d rather implement the portfolio strategy themselves to look at their holdings and read their methodology. His reasoning is that he believes the majority of investors would rather opt for the convenience of holding the entire portfolio through a single fund rather than monitoring disclosures for changes regularly.

Disclosure: No positions in above-mentioned names.

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