Morningstar Advisor - October/November 2013 - (Page 45)

when its asset base stagnates below $100 million. Assessing fund closure risk is important. Shuttering a fund may result in a taxable event for investors; it could be accompanied by associated costs, some of which may be borne by investors; and a liquidation will almost certainly lead to uncomfortable conversations with clients for the advisors that recommended the ETF. The data show that investors already know this and are generally avoiding smaller funds. The 46 actively managed ETFs with less than $100 million in assets hold just 7% of total active-ETF assets. Most of these smaller funds will likely languish and many will ultimately die on the vine. Four have closed this year and more will follow. Actively managed ETFs with less than $100 million in assets have accounted for just 6.4% of net inflows into the category the past 12 months. Low costs are one of the hallmarks of the ETF wrapper. Unfortunately, that would not be immediately apparent to someone examining the current lot of active ETFs. One fourth of active ETFs have annual expense ratios in excess of 1% (albeit those funds account for just 5% of active ETF assets). Meanwhile, the asset-weighted expense ratio of the group of active ETFs with more than $100 million in assets is just 0.55%, largely due to the influence of PIMCO Total Return. This is further evidence that investors have already spotted many of the weeds in this field. The More Liquid the Better It is vital that fund companies never forget what the “ET” in ETF stands for. Working with market makers to foster liquidity in their funds’ shares is a key aspect of creating a favorable investor experience. The failure to keep markets honest on the part of the fund sponsor could result in wide bid-ask spreads or persistent premiums or discounts versus the fund’s net asset value. These dislocations could result in additional costs to the end investor, costs that don’t enter The $100 Million Line: Looking at asset size is a good way to separate good active ETFs from the bad. More Than $100 million Less Than $100 million 18 46 $13.34 billion $1.08 billion 93% 7% Simple Avg Expense Ratio 0.72% 0.88% Asset-Weighted Avg Expense Ratio 0.55% 0.81% Median Avg Daily Vol (Shares, Trailing Three Months) 92,959 6,447 Number of Funds Total AUM Percent of Total AUM Data as of Aug. 12, 2013 the equation when dealing in traditional mutual funds. I looked at the average liquidity levels for the current lineup of active ETFs, breaking the group into two along the size levels I mentioned above. There are clear differences. The median of the average daily trading volume amongst the active ETFs with more than $100 million in assets over the trailing three months was 92,959 shares per day. This is more than 14 times the comparable figure for the group with less than $100 million in assets. Scant liquidity is another reason why these funds will likely languish. Markets Local Debt ELD and WisdomTree Asia Local Debt ALD are subadvised by an experienced fixed-income team at Mellon Capital Management Corp. The SPDR Blackstone/GSO Senior Loan ETF SRLN marks GSO/Blackstone’s first foray into a vehicle offering daily liquidity in the bank loan sector. GSO/Blackstone is one of the world’s largest loan buyers, occupying an important position in a somewhat esoteric and fairly illiquid asset class. And like its larger sibling PIMCO Total Return, the PIMCO Enhanced Short Maturity ETF MINT taps into the Newport Beach, Calif.-based firm’s procedural rigor and deep bench of experienced analysts and portfolio managers. Pillars of Success The pillars of the Morningstar Analyst Rating for funds are also pillars of success in the land of active ETFs. It is no coincidence the largest actively managed ETF, PIMCO Total Return, happens to be the sibling of the largest mutual fund on the planet. Gold-rated PIMCO Total Return PTTAX has employed a rigorous process to handily best its benchmark since its inception in 1987 with Bill Gross, Morningstar’s Fixed-Income Manager of the Decade for the 2000s, at the helm. Similarly, the remaining four funds that make up the five largest actively managed ETFs also have experienced specialists working behind the scenes. WisdomTree Emerging So, while active ETFs may be the new kids on the block, the people behind the segment’s success stories have proven processes and track records that testify to their merit. The Not-So-Secret Recipe There is no secret recipe for success in active ETFs, but there are some common ingredients in those funds that have flourished. The most successful active ETFs have generally been those sponsored by established firms. The managers at the helm are experienced and have proven track records. More importantly, these funds have successfully leveraged the attributes of the ETF wrapper to reduce costs for investors. MorningstarAdvisor.com 45 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2013

Morningstar Advisor - October/November 2013
Contents
Contributors
Letter From the Editor
How to Make Social Media Work for You
Do Mutual Funds Still Have a Role?
More Personal Than Finance
How to Handle Your TIPS Positions
A Real Estate Veteran Starts From Scratch
Investments á la Carte
Investment Briefs
When to Say No
Take a Guarded Approach to Homebuilders
Fund Distribution Has Been Turned on Its Head. Now What?
Winning the Distribution Battle
Active ETFs Wait for Their Heyday
A Fund Firm Defies Indexing Trend
Piloting New Channels
A Good Fit
The Predictive Power of Fair Value Estimates
Does Being Prudent Pay Off?
Utilizing Utilities’ Total Return
Stuck in the Middle Is Not a Bad Place to Be
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Good Guys Win

Morningstar Advisor - October/November 2013