Institutional investors have for the most part resisted actively managed exchange traded funds since they came to market five years ago. What will it take to convince pension funds, endowments and other large institutional investors to use active ETFs?
The possibility of front running, or cherry picking, is what concerns institutional investors the most. Ari Weinberg for Pensions & Investments reports that larger investors would have to look at ETFs from a different angle if they are to use active ETFs in their strategies. Currently, ETFs are used by hedge funds and the like for manager transitions and liquidity.
“Is there a way to protect portfolio management while providing enough transparency so that market makers can make efficient markets?” asked Michael Mundt, who left the SEC in 2011 after almost 14 years. During his tenure as a regulator, he helped draft the active ETF concept release in 2001 as well as the 2008 ETF rule proposal and oversaw the office approving exemptive relief.
There are about 56 active ETFs trading, and of those, the top four by assets are from the fixed income sector. Actively managed equity ETFs have been a harder sell to both individual and institutional investors, according to the P&I report.
The faster regulatory process that has been suggested by BlackRock to the Securities and Exchange Commission could enhance the active ETF. The ETF manager has suggested that non-transparent ETFs be put on a different path through the approval process.
The idea is to keep ETF intraday pricing fair for all market participants while moving disclosure to quarterly from daily, the current requirement for active ETFs. The filing has yet been officially noticed by the SEC.
Another step toward bringing higher asset levels to active ETFs involves the ongoing reform for the $2.65 trillion money market mutual funds. Weinberg reports that Onur Erzan, a New York-based partner at McKinsey & Co. and lead author of “The Second Act Begins for ETFs,” sees the discussion of floating net asset value for money-market funds as a half-step to ETF conversion and intraday liquidity.
“There will be focused opportunities where active ETFs make sense,” said Shundrawn Thomas, Chicago-based managing director of Northern Trust’s ETF group, FlexShares, but issuers will have to “really clarify the value proposition.” Several advantages of passive ETFs, such as transparency, liquidity and total cost of ownership, do not necessarily translate to active strategies.
Tisha Guerrero contributed to this article.