Managed ETFs may invade U.S.

Exchange-traded funds that are actively managed may be making an appearance in U.S. markets soon.

At least one application has already been filed with the Securities and Exchange Commission for what would be the first such ETF, according to sources at the American Stock Exchange.

The SEC refused to comment on the subject, and the identity of the product sponsor will not likely be made public for at least nine months.

The confidential filing represents a significant turning point in the development of ETFs. The focus on actively managed ETFs increased in November when the Frankfurt Stock Exchange began listing 11 hybrid ETF portfolios that could become rough models for U.S. versions.

But first, potential sponsors will have to overcome strong reservations by the SEC. Some say it may be years before the SEC acts.

The SEC’s initial concerns about actively managed ETFs involve their ability to provide full and real-time portfolio disclosure, a requirement if the specialists that support the ETFs are to maintain appropriate hedging positions.

The hitch, as the SEC sees it, is that real-time public access to the buying and selling by a portfolio manager would allow others to copy and even undermine a manager’s trading strategy.

According to the Financial Research Corp. in Boston, the SEC is also concerned about encouraging the day trading of mutual funds.

feasibility addressed

“We’ve done a lot of thinking and a lot of talking about actively managed ETFs, and I don’t think it’s impossible,” says Gary Gastineau, managing director at Nuveen Investments in Chicago. “The SEC has said they are concerned about a number of issues. Well, we think it’s possible to meet the SEC criteria and have an actively managed ETF.”

Last week, Nuveen announced it had filed for approval by the SEC to offer five new ETFs pegged to fixed-income indexes, which will introduce a new twist to the original model of equity-indexed ETFs.

Proponents of actively managed ETFs believe there are ways around the SEC’s concerns.

“Actively managed ETFs can be done provided the managers are willing to reveal what’s in the fund every day,” says Nate Most, chairman and president of Barclays ETFs.

Mr. Most, who created the first ETFs while heading product development at the American Stock Exchange in the early 1990s, says a simple solution to disclosing the actively managed portfolios would be to limit trading to once a day.

The model now being used on the Frankfurt exchange by a unit of Germany’s Deutsche Bank discloses the portfolios to floor traders on a two-day delay. The information isn’t shared with the general public until it is about a month old.

That system would have a slim chance of winning SEC approval.

“I think, in Frankfurt, instead of fixing the problem, they’ve decided to see if there is a problem,” says Kevin McNally, an analyst with Salomon Smith Barney in New York.

Mr. McNally believes that actively managed ETFs are an inevitable part of the future of the financial services industry.

“I think you would have to limit trading to a certain time of day, and you could disclose the portfolio over the Internet,” he says. “I don’t see what the problem is.”

Tom Taggart, managing director at Barclays Global Investors in San Francisco, also believes that actively managed ETFs are coming. But he says the pace of the SEC in approving the hybrids will require patience.

“We certainly see them coming down the road, eventually,” he says. “But unless someone is able to get through the SEC quicker, we don’t see a U.S. actively managed ETF coming out for a couple of years.”

barclays in the lead

Barclays leads the industry, with 60 ETF portfolios (40 of which were launched last year), but State Street Global Advisors in Boston leads the market in terms of ETF assets.

Originally created in 1993 in an effort to bring new business to the Amex, ETFs account for a total of $70 billion in assets under management in 91 portfolios. The ETF assets, up from $9.8 billion three years ago, represent about 15% of all indexed fund assets, according to the Financial Research Corp.

ETFs, which had an average daily trading volume of 45 million shares last year, represent about half of the Amex’s daily volume.

Unlike most mutual funds that are priced only at the end of the day and can be bought or sold only once a day, ETFs are purchased and priced just like an individual security. ETF investors also have the flexibility to do such things as buy on margin, which you can’t do with a mutual fund, and sell short on a down tick, which you can’t do with an individual security. ETF management fees are about half the typical fee for index funds.

Of course, tax efficiency is perhaps the ETF’s biggest advantage over traditional mutual funds, since the structure dramatically reduces the capital gains that mutual funds distribute.