We’ll come to the new active ETFs later but first of all I was intrigued to come across an article on passive funds in the Wealth Management Special Supplement to the January edition of Money Observer.
The article, ‘Get the Right Fit on Risk and Costs’ actually has some fairly mainstream recommendations about mixing passive and active funds (not just active ETFs but mutual funds, too).
What wasn’t unexceptionable was the version of recent ETF history that you might infer had taken place. The article says that are not based on in-kind replication (those that are not physically backed in other words) are by far the most common. Putting that way makes it sound as if finding ETFs that invest in the assets in the index that’s being tracked is really hard and, it’s true; if you choose your funds with a drawing pin and your eyes shut, you are more likely to come across a synthetic ETF than one based on in-kind replication. But there are plenty of the latter out there and there are ETF sponsors such as HSBC, iShares and Invesco Powershares that focus exclusively or mainly on in-kind replication. Finding physically backed ETFs is really not that difficult.
My second beef with this article is the language used in describing synthetic ETFs; replicating the performance of the index through the use of derivatives. This is perfectly true but what’s missing from the statement is the useful qualification that nearly all synthetic ETFs use just one basic kind of derivative, a swap. The article then goes on to explain the collateral risks of synthetic (or swap-based, as I prefer to call them) ETFs and here, too, the explanation is on the simple side of genuinely helpful. There’s no mention of the UCITS requirements for collateral risk to be kept to within 10% of level of the assets being tracked or of the fact that in-kind ETFs are also exposed to collateral risk through their sponsors stock lending activities. These two facts almost seem tired after the coverage they had in 2011 but it looks as if there’s good cause to keep on trotting them out.
This kind of treatment lends weight to financial advisers case for their own indispensability but, if someone is ready to put in the ‘leg-work’ of reading Money Observer in the first place, getting a better grip on the essentials of the ETF industry really shouldn’t be that hard.
The first of the two active ETFs that ETFStall is looking at today is an active Russian ETF sponsored by Alpcot Capital Management, Alpcot Active Greater Russia ETF. To begin with the ETF is only going to be listed on Stockholm’s NASDAQ OMX Exchange with further listings depending upon investor interest. The new fund’s approach to the problematic area of disclosure is for some holdings to be disclosed (presumably daily) and others to remain undisclosed roughly in the proportion of 4:1. The sponsor will provide an indicative net asset value estimate through the trading day. The ETF will be physically backed but, presumably, creations and redemptions will have to be at least partly in cash. How active the selection of the disclosed part of the portfolio will be and whether the selction of the undisclosed assets is pure active manager skill or ears close to the ground hearing information otherwise unobtainable remains unclear.
The chilling ‘Greater’ in the name signifies investments will be made in other countries within the Commonwealth of Independent States in addition to Russia. The management fee will be 1.4%.
The second active ETF is probably more trend setting as it crystallises the idea of an ETF of ETFS. The db x-trackers SCM Multi Asset ETF will invest in other ETFs under the guidance of the ETF asset allocation specialist company, SCM. The expense cost of the ETF will be 0.89% and this is inclusive of the aggregate total expense ratios of the underlying ETFs.
And to return to my starting point, the supposed difficulty of ETF investing: active ETFs are outside its main subject focus so ETFStall has no opinion to offer except to say that this is an area where financial advisers really do have a part to play.