Which Asset Classes Are Active ETFs Fit For? | ETF Trends

This is a special guest post from Shishir Nigam, author of Active ETFs in Focus.

That’s the question that Lee Conrad, blogging at the onwallstreet.com, asked last week in this post – where do actively-managed ETFs fit in?

Conrad holds that one basic area where active management in ETFs can add some value is in cases where indexing is not all that easy. In markets such as high yield bonds or emerging market bonds, it is not very easy for someone looking to replicate an index to minimize the tracking error because very often, the securities held by the index are not very liquid. In other words, the indices covering that particular segment of the market may not be very “investable”. Conrad provides an example of the SPDR Barclays High-Yield ETF (NYSEArca: JNK) which underperformed its benchmark by a whopping 13% in 2009 with a tracking error of 2.84%. Another example is the SPDR Barclays International Treasury Bond ETF (NYSEArca: BWX) which underperformed its benchmark by 2% with a tracking error of 3.18%, as of Sept 30, 2010. Certain segments of the fixed-income market are definitely hard to track through an index and investors should expect to see large tracking errors. And that is where active management of the ETF can come in, so that portfolio managers can decided which securities they want to own, as opposed to being obligated to purchase all the constituents of the index, regardless of liquidity constraints.

At the moment, there are no actively-managed ETFs for the high-yield bond market but AdvisorSharescurrently has one in the works that is being launched in conjunction with Peritus Asset Management, which will sub-advise the fund. The launch of that fund will provide a good indication of whether investors warm up to active management in ETFs within the high-yield space. RiverPark Advisors is another player which has a short-term high-yield bond Active ETF in filing with the SEC. RiverPark currently serves as the sub-advisor on several actively-managed equity ETFs launched by Grail Advisors.