Funds' Active Interest in ETFs

Asset managers watch the move toward actively managed ETFs.
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Most mutual fund companies have largely steered clear of the fast-growing exchange-traded fund space. But the entrance of actively managed ETFs could change the calculus for many traditional asset managers.

Currently, there are about 300 ETF products trading in the U.S. with almost $400 billion in assets, and almost all of them track indexes such as the

S&P 500

. But some people are working on creating actively managed ETFs, which would allow portfolio managers to have a hand in the securities picking.

N.J.-based Managed ETFs LLC has an application filed with the

Securities & Exchange Commission

for an active ETF. Others, including the American Stock Exchange, are working on similar offerings. Such products would be a better complement to traditional active money management businesses, where portfolio managers attempt to create a portfolio that will outperform a benchmark vs. the current crop of ETFs, which seek to replicate indexes.

Thomas Faust Jr., president and chief investment officer of Eaton Vance, which offers actively managed funds, acknowledges that an active ETF would pique their interest in the ETF space.

"We certainly watch the ETF space with interest," he says. "I think if there are actively managed ETFs we would want to be involved."

Once active ETFs hit the market, "a lot of people who are involved in active management of mutual funds will be involved in active management of ETFs" says industry veteran Gary Gastineau, co-founder of Managed ETFs. "They recognize that when one person does it, a lot of people will do it. It is absolutely inevitable."

Ronald DeLegge, publisher and editor of ETFguide.com, agrees the impact of an active ETF would be far reaching.

"It will turn the world upside down," DeLegge says, adding: "It'll get not just the ETFs industry's attention but

it will get the active management industry interested in jumping on the ETF bandwagon."

Still, DeLegge and others suggest caution. For instance, DeLegge says that when an active ETF does launch, it will be a very complicated product structure and some of the crucial things that traditional ETFs offer, such as transparency of holdings, will be lost.

There's also the issue of who will be first to market.

"If you're going to be the first person

to introduce an active ETF you are taking on a certain amount of effort ... people that are very much committed to the mutual fund structure are hesitant to be the first person to take that step," Gastineau says.

However, he adds, "Based on the conversations we've had there are an awful lot of people out there who would like to be second and third in terms of introducing active ETFs."

In addition to using an active ETF to get in the ETF door, some believe mutual fund companies may look to get into the ETF space by buying a company that already offers ETFs.

For example, AMVESCAP recently closed a deal to acquire ETF provider PowerShares Capital Management. At the time, PowerShares had about $3.5 billion in assets and 36 ETFs, though that has since increased substantially.

"I think it would be naïve to think that these

mutual fund companies haven't thought of a back-door way to ETFs," says Rob Lee, an analyst with Keefe Bruyette & Woods who covers many of the publicly traded asset managers.

Indeed, the asset management industry's faith in its current model is expected to be on display this week when bids for

Marsh & McLennan's

(MMC) - Get Report

mutual-fund unit Putnam Investments are due. Bids are expected from Amvescap Plc, Unicredito Italiano SpA and Power Corp, according to

The Wall Street Journal

.

Still, Jim Ross, senior managing director of SSgA and president of SSgA Funds, believes some new ETF companies may be entering the ETF space for the sole purpose of being bought within a few years.

It's tough to say exactly who those companies are but one that is often said to be a possible buyout target is WisdomTree, which launched its first ETFs earlier this year. WisdomTree's ETFs are based on indexes that weight according to dividends. They recently hit $1 billion in assets.

Other possibilities include Claymore Securities, which entered the market this year, and First Trust, which launched its first ETF in 2005.

Neither company could be reached for comment.

While mutual fund companies may ultimately look to get involved with ETFs through the creation of active ETFs or by purchasing an ETF company, KBF's Lee says at this time many asset managers will continue to steer clear of ETFs.

"Right now I don't get a sense that

getting into ETFs is a priority for the companies I cover," says Lee, whose coverage area includes

AllianceBernstein

(AB) - Get Report

,

Janus Capital

(JNS)

,

Franklin Resources

(BEN) - Get Report

,

Eaton Vance

(EV) - Get Report

and

Federated Investors

(FII) - Get Report

. (KBW expects to receive or intends to seek compensation for investment banking services in the next three months from each of the companies mentioned.)

But some believe mutual fund companies could be threatened by ETFs once they make meaningful progress in the 401(k) space.

"Mutual funds still have the advantage of having a stronghold on the 401(k) retirement marketplace," says DeLegge of ETFGuide.com. However, that could change if ETFs gain meaningful ground in the 401(k) space.

An issue that has largely kept ETFs clear of 401(k)s and other plans where investors make small, regular investments is that they trade like stocks and therefore investors pay brokerage commissions each time they trade. But many companies have been working on solutions and some are gaining traction.

Portland, Ore.- based Invest n Retire has designed a platform to bundle trades to avoid commission costs. But a bigger trend has been toward wrapping ETFs in a fund-of-funds type structure or putting them in a collective investment trust. Some companies that are doing this include Rydex Investors, Federated Investors, XTF Advisors and J.W. Seligman. (Increasingly companies have been creating these types of products as target-date portfolios, which are highly popular in the retirement market.)

While it's hard to say if or when ETFs will really take off inside 401(k)s, many expect that when they do, companies committed to mutual funds will sit up and take notice, if not action.