Introducing the next small thing in investing: the actively managed exchange-traded fund.
If you're one of a growing number of investors familiar with ETFs, then you might well be aghast at yesterday's introduction of the Horizons AlphaPro Managed S&P/TSX 60 Fund (HAX-TSX). If you aren't hip to ETFs yet, then suffice it to say this product represents a dismissal of the fundamental concept behind exchange-traded funds.
ETFs are all about investing directly in stock and bond indexes, rather than in portfolios of securities selected by mutual fund managers. The reasoning here is that many, if not most, actively managed mutual funds end up underperforming their respective benchmark indexes over time.
And yet the whole point of the new Horizons AlphaPro ETF is to use research provided by noted technical analyst Ron Meisels (who writes on Saturdays for this newspaper), to outperform the S&P/TSX 60 index of big Canadian blue-chip stocks. Technical analysis means evaluating price and volume trends for stocks and indexes to determine future trends.
Here's some irony for you on the matter of how best to run ETFs. The president of the company behind the new AlphaPro ETF is Howard Atkinson. In a previous job at Barclays Global Investors, he helped make the iShares Cdn LargeCap 60 Index Fund, the colossus among Canadian ETFs. This fund is a highly efficient way to put the performance of the S&P/TSX 60 index fund in your portfolio; individuals and institutions have invested $7.7-billion in it.
Mr. Atkinson's take on index investing versus active management is that intelligent investors use the two approaches in combination.
“The largest money managers and largest pension plans in the world use both strategies,” he said.
Conventional ETFs like the iShares Cdn LargeCap 60 have surged in recent years in both assets and trading volumes, but they can still be considered the next big thing because of their potential to peel assets away from mutual funds. A few actively managed ETFs have been issued in the U.S. and Canada, but they're marginal players. They just don't have the powerful underlying argument of index investing working in their favour.
And yet, there are certainly some advantages to getting your active money management through an ETF as opposed to a conventional mutual fund. While the cost of owning the AlphaPro fund is high in ETF terms at 0.7 per cent, it's a bargain compared to most any widely available Canadian equity mutual fund.
Here's a real-life example of this fee savings. In its previous life as a total pooch of a mutual fund called JOV Talisman, the AlphaPro ETF had a bloated management expense ratio of 2.81 per cent.
Like any ETF, the AlphaPro fund can be bought and sold at any time of the trading day, whereas mutual funds must be traded at end-of-day prices only (or the end of the following day if you place a trade later in the afternoon). In volatile markets, this superior level of liquidity gives investors a lot more control.
Another benefit of ETFs in general is that they produce fewer taxable gains for the investors who own them than mutual funds. Mr. Atkinson said active ETFs may not be as tax-efficient as index ETFs, but they should still beat regular mutual funds.
A few actively managed ETFs have been introduced in the U.S. market over the past year, but they've primarily focused on bonds and so-called “enhanced indexing” strategies that take index stocks and apply rigid, preset filters to select those with certain characteristics. Here in Canada, Claymore Investments claims that its Claymore Canadian Financial Monthly Income Fund (FIE-TSX) was the world's first actively managed ETF. However, this fund is primarily a vehicle for producing investment income, not beating indexes.
The AlphaPro ETF is notable for highlighting its use of active management with a goal of outperforming a specific index. The fund's strategy is to start with the stocks in the S&P/TSX 60 index and then adjust according to Mr. Meisel's research. Some stocks and sectors will be overweighted, others cut below index level and some dropped. The fund may hold cash as well.
The acid test for this ETF is simple: Outperform the 60 index by enough to make it a better choice than the iShares Cdn LargeCap 60 ETF. “We have to do better than that to make it worthwhile, and we expect to be able to do that,” Mr. Atkinson said.
Some actively managed funds will always outperform the index, but a lot won't. That's why actively managed ETFs are investing's next small thing.