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Active ETFs: Investing Revolution or More of the Same Hype?

by: Index Universe posted on: June 30, 2008

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By Jim Wiandt

I've been trying to decide if active ETFs are an investing revolution or just more of the same hype.

It's funny Matt Hougan should bring up the Vanguard share class issue. The language I hear from everyone around the ETF industry is that the patent would never hold up. But I have not yet seen anyone launch an ETF off of an existing fund. So (perhaps as with ProFunds) it appears that Vanguard had frightened off people with its size long enough to get a big head start anyway.

The question is whether THAT is the case, or whether others are just not interested in the share class concept. You've got to understand that with Vanguard, the issues were a bit different than they would be with a large active shop like, say, American Funds. Vanguard had its dedicated base of retail investors, who probably more than almost any other fund provider are likely not going anywhere else. AND they had no advisor constituency to speak of since shutting down their intermediary business some years ago. The bid to get those guys back (and boy have they and then some) AND improve the capital gains position of the funds, etc., has worked out. But it's not a model that would work for most large active shops - who see mostly downside in going to the secondary market, for all the reasons I listed in my last blog.

Add to that the fact that, by and large, a pure ETF structure is going to be a better structure than a mixed structure (save a couple of recent dramatic examples in less-liquid asset classes where the fund/ETF mixed structure can provide dramatically better diversification and tracking AND sometimes tighter creation units as well. See Emerging Markets last year and, frankly, bonds in general). Still, if I'm an ETF investor, I'll take the pure ETF structure just about anywhere else, all things being equal, because of the creation and redemption process and the added benefit it will bring to a pure fund over a mixed-share class structure with more capital gains to be clearing out from the (generally) cash side of the fund.

All of that is somewhat academic, though. I think it's fairly easy to say that ETFs are by and large a better mousetrap, whether with a mixed or pure structure, and that active funds and their investors would be better served in an ETF structure. But we've concluded here long ago that it's not REALLY about investors, right? Fund companies are competitive to the degree it takes to get their money, & then it's all about profit protection. Can I be any clearer about that? It's an imperfect sort of capitalism, but I guess it's capitalism in general, right? You buy a brand of toothpaste or toilet paper and pay up for and remain loyal to the brand, even when someone may come out with something that makes your teeth whiter or (OK, I'll steer clear of the toilet paper analogy, but you get my drift).

I'll drop in one more bit here. We LOVE Vanguard, but we also like to keep them honest. To our stunned surprise, we (that's the staff of Index Publications) went with FIDELITY for our Simple IRA plan because it's simply a better deal. I think Team Vanguard loses some other starting index investors for the same reason. I've never been fully sold on the biggest investors at Vanguard throwing out the riffraff in the interest of paying for your own costs, but I KNOW our costs are lower than what they wanted to charge us in fees for the Simple IRA, at $25 PER FUND PER YEAR no MATTER the amounts; that's 50 basis points in fees even if you've got 5 grand in the fund for each fund, which strikes me as absurd. Fidelity charges $350 (or $25 each investor TOTAL) in maintenance fees for the whole company AND offers a family of 10 basis point index funds. So I guess we see why those funds have assets.

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