Active managers and ETFs
ETFs have important role for some
Exchange-traded funds (ETFs) offer pure asset class exposure with lower costs
and greater tax efficiency than most mutual funds. The greater cost and tax
efficiency are often cited as reasons why these should be used in place of
active managers in many asset classes. Thatís an issue in perpetual debate that
I will not explore in this article. Ironically, however, many active managers
make significant use of these otherwise passive vehicles.
Reduce cash drag
There are many examples today of large cap managers having difficulty finding
new investment ideas into which to deploy their bulging cash reserves. There is
a school of thought in the money management industry that any cash level above 2
percent or so (i.e. fully invested) will inevitably be a drag on returns. So,
when cash is flowing in quicker than it can be invested or when investment ideas
arenít as abundant, some fund managers will use ETFs to put the money to work
until the cash can be deployed.
BPI Global Asset Management has traditionally employed this approach. It is
not uncommon to find, for instance, the BPI American Equity fund holding the S&P
500 Depository Receipts ETF - or Spiders for short (AMEX:SPDR). SPDR is managed
by State Street Global Advisors with a mandate to track the S&P 500 stock index.
And this makes sense given the BPI fundís growth stock picking style and
historically high correlation with the popular index.
Gain asset class exposure
Interestingly other managers will simply use ETFs to gain exposure to a
particular asset class. Motivations could range from a lack of expertise in, or
the inability to apply a managerís investment process to a particular market
segment. Or, a manager may simply want quick exposure to a basket of stocks in a
particular sector with one purchase. With respect to investment process
constraints, many money managers only feel comfortable investing in a firmís
shares if they can obtain face-to-face access to senior executives.
However, a Canadian money management firm with a modest amount of money under
management may have more difficulty getting access to firms (even smaller ones)
based in the U.S., or elsewhere for that matter. Also, even if access were given
to such money managers, it becomes expensive to fly across the continent or the
world investigating stocks that may occupy a relatively small portion of total
Talvest Millennium Next Generation is a Canadian small cap fund. Its foreign
content varies, presumably based on the availability of opportunities in Canada.
When it does hold foreign content, however, this fund will invest in iShares
Russell 2000 Index fund and the S&P 400 Mid Cap Spiders. Both are ETFs that
track U.S. small and mid-cap stock indexes, respectively.
Elliott and Pageís Tax Managed portfolios make extensive use of both bond and
equity ETFs, along with stock picks of other money managers. The tax efficiency
of ETFs investing in stocks is what attracts E&P for this fund. However, itís
rather puzzling that they would buy a bond ETF, rather than a bond directly
given their access to institutional pricing. More than 27 percent of the E&P
Manulife Tax-Managed Growth Portfolio is invested in a variety of ETFs. But
donít expect any fee breaks here. This fundís MER is 2.68 percent per annum.
As the ETF universe has blossomed, a new mutual fund product segment has
emerged - one that is based on market timing these low cost instruments. CI
Tactonics (a product originally created by Spectrum Investments a few years ago)
is based on the body of academic research studying the persistence of recent
past performance. Tactonics essentially uses a model based on price momentum and
volatility to judge which ETFs should be bought, held, or sold.
The original creator of that fund, Karen Bleasby, has helped her current
employer (Mackenzie Financial) launch a similar product using a combination of
ETFs and Mackenzie mutual funds.
I think using ETFs for quick, efficient asset class exposure is fine inside
of a mutual fund. However, when ETFs play a key role in the strategy of an
active manager, I confess to having serious doubts about the ability for such
managers to add any value to compensate for such fundsí typical 2.5 percent
Dan Hallett, CFA, CFP is the President of
Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as
Investment Counsel in Ontario and provides independent investment research to
financial advisors. He can be reached at