The Allure of Actively-Managed Exchange-Traded Funds

On March 25, 2008, Bear Stearns introduced an actively managed exchange-traded fund (ETF): the Current Yield ETF (YYY). As fate would have it, Bear Stearns was just about to go under, and when it did, the first actively managed ETF went with it. Prophetic? Perhaps.

In the three years since, about two dozen actively managed ETFs have hit the street, with very little commercial success. A number of companies, many of them new to the ETF market, have recently sought permission from the U.S. Securities and Exchange Commission to launch ETFs that follow no indexes. These players include PIMCO, BlackRock, Eaton Vance, T. Rowe Price, and Dreyfus.

Speaking in broad generalities, actively managed mutual funds have been no friend to the small investor. Their dominance remains a testament to people’s ignorance of the facts and the enormous amount of money spent on (often deceptive) advertising and PR that give investors the false impression that buying this fund or that fund will lead to instant wealth.

The media often plays into this nonsense with splashy headlines, designed to sell magazine copies or attract viewers, that promise to reveal which funds or managers are currently the best.

Still, active management can make sense — and that may be especially true when some of the best aspects of active management are brought to the ETF market.

Some managers actually do have the ability to “beat the markets” — they are just few and far between, and the increased costs of active management often nullify any and all advantages these market-beaters have.

If those costs can be minimized, and if you can find such a manager, you may wind up ahead of the game. Active management in ETF form may also be both more efficient and more transparent than it is in mutual fund form.

And finally, with some kinds of investments, such as commodities and possibly bonds, active management may simply make better sense in certain cases.

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