Three fund launches over the last few weeks prompt a simple question: what is an ETF?
According to the head of one of Europe’s largest ETF operators, a couple of years ago he would receive regular calls from private equity houses looking to take a stake in his business. Now, he said, it’s asset managers who are on the phone, wanting to find out how they can get more involved in the ETF market.
It’s not just possible merger and acquisition activity that suggests that active and passive fund management are merging. A few years ago, there was little in common between indexing and active fund management, even if a frequently levelled criticism at active managers was that they were “closet indexers”, hugging the benchmark they were measured against and departing only marginally in individual stock weightings.
Now, however, an increasing number of funds make it increasingly hard to distinguish between active and passive management altogether. Take two new funds from Source, launched in the last few weeks.
The PIMCO Source euro enhanced short maturity fund doesn’t track an index. Instead, it seeks to outperform its benchmark (the wholesale euro cash interest rate) through an active management strategy, operated by Andrew Bosomworth and Vineer Bhansali of PIMCO. And yet it’s called an ETF.
The Man GLG Europe Plus Source ETF tracks a highly active underlying index, with turnover levels of 1000% a year or more. The index follows a computer algorithm run by Man Systematic Strategies to select from amongst broker-generated research ideas. It’s active, but it’s also called an ETF.
Meanwhile, JP Morgan Asset Management’s relaunch of its UK Active 350 fund as the JPM UK Active Index Plus Fund is, in the firm’s own words, “designed to offer a viable alternative to passive funds while retaining the ability to outperform, which passive funds are unlikely to do.”
There seems little functional difference between these three funds, except that the first two are labelled as ETFs since they come from an exchange-traded fund provider, while the JP Morgan fund isn’t.
So what does distinguish an ETF? The ability to trade intraday and to have an indicative net asset value that can vary throughout trading hours is one obvious answer. But in the case of the Man GLG Europe Plus Source ETF the fund’s underlying composition is only released to its market makers once daily, making it indistinguishable from a traditional mutual fund that also prices once every twenty four hours. You can trade the Man GLG Source fund intraday, of course, but there seems little point in doing so as you’d be incurring an unnecessary bid-offer spread. You’d be better off placing an order to buy or sell on the basis of the official daily NAV, just as with a mutual fund.
Surely there’s a difference from ETFs in that the JP Morgan fund has a performance fee (albeit capped – the firm says its fund’s total expense ratio won’t exceed 0.55% a year)? But although most ETFs don’t carry performance fees, it’s easy for their underlying indices to factor such charges in, as we wrote about last week in “Beyond the Expense Ratio”.
Fundamentally, the move by active managers to move closer to ETFs in fund design is a recognition of the cost savings that passive products have brought about, something that’s ultimately good news for investors. Active management firms have no doubt been eyeing similar moves for a long time but have been cautious about doing so for fear of cannibalising their existing, high fee fund business.
At the same time, many ETF providers have been recognising that it’s fearfully difficult to take market share from the largest existing index-tracking funds and have been seeking to move into more complex, higher-margin products. As a result, certain offerings from ETF providers and active managers are now pretty much indistinguishable.
Where do we go next? Could active managers start having to provide greater disclosure of their activities in derivatives and securities lending, an area where several ETF providers feel they’ve been subject to scrutiny of a type that active fund houses never have to face? Could there be a split of the ETF market into funds that truly trade intraday and those that don’t? Could the dealing mechanism for many active funds evolve to resemble more the multi-market maker set-up that ETFs use? And will we end up trading all funds on an online brokerage screen, doing away with fund platforms altogether? All these are intriguing questions.
In general, a throwing of the fund management market into flux of this type is surely overdue The resulting competition should ultimately be great news for investors, as costs will come down.
At the same time, there are also new risks. As the exchange-traded fund brand starts to look increasingly blurred, the possibility of a mishap affecting the ETF name as a whole is undoubtedly on the rise. And educating investors about the functional differences between the rapidly proliferating types of fund structure presents a new and formidable challenge.