Volume18, Number 1
January 2012
Single Issue $15
In this issue:
- What’s New
- 2012 – Expect the Unexpected
- 2011 Year End Review
- Precious Metals Shine in Turbulant Times
- Active ETFs Gain in Popularity
WHAT’S NEW
- Happy New Year! I would like to start the year off by wishing all of our readers a very happy and healthy New Year. I also want to thank all of you for your continued support and look forward to providing high quality mutual fund and ETF analysis for you well into the future. Stay tuned, we have some changes in the works which will be rolled out over the next few months. As always, your comments and suggestions are always welcomed at feedback@paterson-associates.ca.
- Popularity of ETFs Grows – The Canadian ETF industry continued to show increasing popularity with investors in November. Net sales for the month were approximately $700 million according to a report released by Blackrock Asset Management, the issuers of the iShares family of ETFs. Factoring in the November numbers, the year to date net sales for Canadian ETFs totalled $6.3 billion. In comparison, the Canadian mutual fund industry saw net sales in November of $469 million, giving it a year to date total of $19.1 billion. From an asset under management perspective, it is estimated that the total assets under management in Canadian ETFs was $41.8 billion in 222 ETFs. The total assets invested in mutual funds are estimated to be $772.6 billion. While the total assets in ETFs are about 5% of the assets invested in mutual funds, sales momentum appears to be on the side of ETFs.
- iShares launch floating rate note ETF – Like traditional bonds, Floating Rate Notes (FRNs) are fixed income investments that pay investors an annual coupon rate of interest over the life of the note and return the principal value of the note at maturity. Unlike traditional bonds which carry a fixed coupon rate, FRNs carry an interest rate that will fluctuate with the prevailing rate of interest in the economy. Because the coupon rate of the FRN rises and falls with the interest rates in general, they tend to hold their value much better in a rising interest rate environment. Investors now have a low cost way to access these types of bonds thanks to a new ETF launched by iShares. The iShares DEX Floating Rate Note Index Fund (TSX: XFR) is designed to replicate the performance of the DEX FRN Index, net of expenses. The management fee of the ETF is expected to be 0.20%, however, iShares will absorb any management fees of the fund until June 30. For those looking to add some interest rate protection to the fixed income portion of their portfolio, this ETF is a great way to do just that.
- Dynamic launches new dividend income fund – Looking to capitalize on the strong track record that recent arrival Cecilia Mo created at Fidelity, Dynamic recently launched the Dynamic Dividend Advantage Class Fund (DYN 2370 – Front End Units). The fund is very similar to the Fidelity Dividend Plus Fund (FID 223 – Front End Units), investing in a wide range of income generating securities such as dividend paying common stocks and REIT’s. The fund has no restrictions to sector exposure or market capitalization. It is Canadian focused and can invest up to 49% of its assets in foreign securities. While the traditional front end version of the fund does not intend to pay regular distributions, there is a “T-Series” available which will pay monthly distributions that will be set at 6% per year. Like other T-Series funds, it is expected that most of the distributions paid to investors will be treated as “return of capital” for tax purposes. The maximum MER is capped at 2.10%, which is reasonable for a Canadian Dividend & Income Equity Fund. While we like the fact that Ms. Mo has a very strong track record running a fund of this type, we would be very hesitant to invest in it at the moment. Rather we would like to see a few quarters of track record under the new fund structure to get a better sense of the fund’s true risk/reward characteristics.
Dave Paterson
2012 – EXPECT THE UNEXPECTED
By Gordon Pape
When uncertainty pervades the markets, let prudence be your guide.
About the only thing I can predict with confidence for 2012 is unpredictability. There are so many uncertainties playing out on the world stage that it is impossible to know how the year will unfold.
In these circumstances, the best advice I can give is to be cautious. Prudence should trump greed, at least until such time as we have a clearer idea of how the European debt crisis will play out, how theU.S.economy is faring, and whether we are headed into another recession. However, that doesn’t mean we have to sacrifice all profit potential. The goal is to identify funds with a strong history and an acceptable risk/return profile. With that in mind, here are three fund selections for 2012.
Equity funds
RBC Canadian Equity Income Fund. This fund, which is on our Recommended List, has done amazingly well in very tough market conditions. Manager Jennifer McClelland has skilfully transformed a former income trust fund into a high-yield equity fund that has outperformed just about everyone else in the Canadian Dividend and Income Equity category. Her focus is on mid-cap stocks, with a value bias in her selection process. Ms. McClelland is an active trader; the portfolio has a turnover rate of 141% which means it is completely overhauled more than once a year on average.
According to Morningstar.ca, the fund was showing a year-to-date gain of 9.2% as of the close of trading on Dec. 28 (A units). That was 11 points above the category average, ranking it number four in its peer group for the period. Over the past three years, the fund has generated an average annual compound rate of return of 33.3%, which should be good enough to please even the most demanding investor.
The portfolio, which has just over 100 positions, is a mix of blue-chip stocks such as Brookfield Asset Management and CIBC, REITs, former income trusts, and various resource companies. About one-third of the assets are in the financial sector with 23.3% in energy, 14.6% in industrials, and 10.4% in materials. The investments are heavily concentrated inCanadawith only a smattering of foreign securities.
The fund offers good cash flow (hence the inclusion of the word “income” in the name) with current distributions running at $0.09 a unit per month ($1.08 per year). Based on a recent NAV of $22.60, that projects to a yield of 4.8% over the next 12 months.
Volatility is slightly above average for a fund of this type so there’s more risk involved here as compared to a traditional dividend fund. However, the strong returns more than compensate for that.
Buy this one for good cash flow and capital gains potential. The code for the Series A no-load is RBF591.
Dynamic Power American Growth Class. I have written about this before but I keep coming back to it because I regard it as one of the bestU.S. stock funds available. But a word of warning: it comes with higher than average risk.
According to Morningside, as of Dec. 28 the fund had posted a year-to-date gain for 2011 of 6.3%, making it the fifth-best performer in its category, more than seven percentage points above average. The three-year average annual compound rate of return was 19.7%. An investment of $10,000 made in December 2008, at a time when the economic outlook was bleak, would be worth $17,155 now.
Manager Noah Blackstein continues to do very well with an unconventional mid-cap portfolio that makes relatively large bets on his favourite stocks. As of Oct. 31, his top holdings included such unfamiliar names as TIBCO Software, VMWare, BroadSoft, Under Armour, and Alexion Pharmaceuticals. As you may have inferred from those names, his main emphasis is currently on information technology stocks, which make up slightly more than half the portfolio (52.2%). Interestingly, that’s the same allocation he had at the start of 2011. Obviously, it’s working.
The negatives are a relatively high MER (3.61% for the class A fund units) and above-average volatility. This isn’t a good choice for nervous people; the fund lost more than 44% in 2008 when markets plunged. But for those willing to accept above-average risk for the prospect of outstanding returns, this fund is a top choice. There is also a currency-neutral version available if you want to eliminate the exchange rate factor from the equation although it has not done as well as the core fund recently.
There are many variations of this fund so check with your financial advisor or Dynamic for the appropriate code for the types of units you want. The minimum initial investment is $500.
Balanced funds
Fidelity Monthly Income Fund. This fund offers a well-balanced portfolio, which is just the sort of thing we need in turbulent times. It is a consistently strong performer, beating its peers over all time periods by a substantial margin and earning a five star rating from Morningstar.
During a year when many funds lost money, this one posted a gain of 5.7% in 2011 (to Dec. 28), the third-best in its category. For the three years to that date, the fund showed an average annual compound rate of return of 16.5%, a very fine result for a conservative portfolio such as this. That was good enough for second place in its group.
However, this does not mean the fund is immune from market downturns: it dropped 21.5% in the year ending Feb. 28, 2009. But most equity and balanced funds did worse during that period. Fidelity rates the risk as below average on its volatility meter.
This is a huge fund, in all ways. It has accumulated over $4 billion in assets since it was launched in November 2003 (all series). The portfolio holds a breathtaking 1,659 positions, 272 of which are equities and the rest bonds. Stocks make up about 43% of the fund with about the same weighting in bonds, and 11.4% in cash, so the portfolio is quite defensive in nature. Foreign content is about 30%.
The main negative is that cash flow is thin if you need regular income. Monthly payments vary but were less than $0.02 a unit for most of 2011.
The managers use a value approach to stock selection and the MER for the B units is a reasonable 2.09%. There are 44 different types of units for this fund so check out the Fidelity website for the appropriate code.
In closing, I’d like to take this opportunity to wish all our readers a happy, healthy, and prosperous New Year.
2011 YEAR END REVIEW
By Dave Paterson, CFA
Market uncertainty and high volatility set the stage for 2012
After posting strong gains in 2009 and 2010, equity markets went on a wild ride in 2011 as global uncertainty was driven to new heights. The year started off with promise as the market rally continued into March when worries over the impact of the earthquake and tsunami in Japan rattled investor confidence, prompting the first of many sell offs over the course of the year. While the earthquake aftermath was horrific in terms of the human toll left in its wake, the economic impact was only temporary.
Throughout the year, the real economic toll was caused by debt troubles in Europe and theU.S.In theU.S., policy makers spent the summer trying to hammer out a deal which would allow theU.S.debt ceiling to be raised. Without it being raised, theU.S.would have been forced to take dramatic actions which could have included such things as shutting down some or all of the government or a default on its debt payments. Neither option was particularly palatable, and while a deal was eventually reached, the damage had been done. The end result of this process was a downgrade on the country’s debt from AAA by ratings agency Standard & Poor’s.
Europe struggled with a mounting debt crisis that finally boiled over in early 2011 after public outcry and riots inGreeceover proposed austerity measures made it front page news. While a number of bailout packages were proposed forGreeceover the year, a workable, long term solution is far from fruition. Debt troubles were not isolated toGreeceas other countries were also impacted includingPortugal,Spain,IrelandandItaly, which saw the yields on their debt pushed skyward. While none of these countries appear to be in the same dire financial straits asGreece, lingering concerns regarding solvency and liquidity continue to erode investor confidence.
This lack of confidence has had a pronounced impact on the investment markets. InEurope, the MSCI Europe Index dropped by more than 10% in Canadian dollar terms in 2011. Until a workable solution to the debt crisis is implemented, it is expected that high levels of market volatility will remain, making it a very tricky place in which to invest. Further complicating matters is that the uncertainty has clipped economic growth, with many expecting that Europe is currently or will soon be in a recession.
The volatility has also impacted the emerging markets, particularlyAsia, which depends on the developed world for their exports. The MSCI Asia Index was down by more than 16% on the year while the MSCI Emerging Market Index dropped by 17%, both in Canadian dollar terms. Any recession in Europe and slower growth inNorth Americacould result in a further slowdown of economic growth in the emerging markets in 2012. While growth is expected to slow in 2012, it is still likely to outpace the developed world economies.
With volatility first and foremost on the minds of investors, it is not surprising that gold and fixed income investments performed very well in 2011. Investors flocked to such safe haven investments with the DEX Universe Bond Index jumping by nearly 10% for the year. Long term bonds and real return bonds were also benefactors, rewarding investors with returns of around 18%. With uncertainty likely to remain high and economic growth expected to be modest at best, it is widely expected that both the Bank of Canada and the Federal Reserve will keep their overnight rates at the current low levels for the year. As a result, we expect that fixed income investments will have another positive year, however, we do not expect 2012 returns to match 2011.
Gold also benefitted from the safe haven appeal, moving higher by more than 10% in U.S. dollar terms. The gain would have been much higher had it not been for a sharp drop off in price during the last two weeks of December. A somewhat interesting divergence occurred during the year where we saw the performance of gold bullion dramatically outperform gold company stocks. The S&P/TSX Materials Index which is made up largely of mining companies was down by nearly 22% on the year. Historically, the performance of gold mining companies has been fairly highly correlated to the price of the underlying bullion. Given this historic trend, we expect that gold mining stocks will outperform gold bullion in 2012. (For our picks on Gold and Precious Metals Funds, please see our article Precious Metals Shine in Turbulent Times elsewhere in this edition.)
The S&P/TSX Composite Index suffered in 2011, dropping nearly 9% on the year. Six of the ten industry sectors were down, including the heavyweight financials, materials and energy, which were down 7.5%, 21.8% and 16.8% respectively. Healthcare and telecom were the big gainers for the year.
In theU.S., despite the uncertainty caused by the debt ceiling stalemate, the economy is showing signs of life. The employment picture is improving, the housing market is stabilizing and retail sales have been strong. These factors point to a continuation of the modest improvement in economic growth that we saw in the second half of the year. During 2011, the S&P 500 rose by 5.6% in Canadian dollar terms, however that gain was solely attributed to the drop in the Canadian dollar. We expect that as confidence returns, markets will move modestly higher during the year.
Looking ahead, we expect that volatility will remain high for the next quarter or two. Given this uncertainty, it is our opinion that investors should focus on quality in 2012. Fixed income investments should continue to play a key role in investor’s portfolios. It is our expectation that interest rates will remain at or near current levels for the year. We feel that investors should focus on high quality, corporate focused bond funds that allow the managers the flexibility to adjust the portfolio to benefit from the environment.
For equities, again, we believe the focus should be on quality. Investors should focus on high quality, large cap focused funds where the managers place an emphasis on dividends. These types of funds should hold up better during periods of elevated volatility. Further, given the continued uncertainty inEurope, we feel that the risk/reward environment favours North American focused investments. Some aggressive investors may want to consider dipping their toes in the emerging market space, but we do expect that volatility will remain high in the region.
Given our expectations, here are three funds which we feel will serve investors well in the coming year:
TD Canadian Bond Fund (TDB 162) – A perennial favourite in the fixed income space, this high quality bond fund is consistently in the first quartile. The fund is focused on high quality issues from Canadian corporations and governments. The fund is currently holding 59% in corporate bonds, all of which are investment quality. The fund is large and the managers are patient, typically implementing any changes in portfolio positioning on a gradual basis. Given the fund’s positioning, management team, and modest cost structure, we expect that the fund will again outperform its peer group in 2012. However, on an absolute basis, we expect that returns will be lower than in the previous three years.
Fidelity Canadian Large Cap Fund (FID 231) – This Canadian focused equity fund managed by Daniel Dupont since April 2011, has consistently outpaced much of the other funds in the category. Since taking over the reins of this fund from Brandon Snow, Mr. Dupont has transitioned the portfolio to be more concentrated and value focused. The manager, who is very active in overseeing the fund, has great flexibility as he can invest up to 49% of its assets outside of Canada. As of November 30 the fund has 41% of its assets in foreign equities. Given the manager’s active approach, combined with the high quality nature of the underlying portfolio, we expect that this fund will outperform its peer group in the coming year.
Dynamic American Value Fund (DYN 041) – Despite recent underperformance, this is a fund that we believe will reward investors in 2012. This very actively managed U.S. equity fund is run by David Fingold, who uses a fundamentally driven, bottom up approach looking for quality companies that are trading at significant discounts to their true value. In addition to being an active manager, Mr. Fingold is also a high conviction manager in that he will take very concentrated positions in a small number of securities. The fund will typically hold between 30 and 40 securities. Long term performance has been impressive, as has been the manager’s ability to handle portfolio volatility.
By Dave Paterson, CFA
Investors have several options to gain gold exposure in their portfolios
Recently, investor interest in gold and precious metals has reached an all-time high. Many investors may be looking to add some gold exposure to their portfolios in an effort to take advantage of gold’s safe haven appeal during periods of uncertainty in addition to gold’s ability to act as an effective hedge against potential inflation.
There are basically two ways to gain exposure to gold and precious metals in your portfolio – either by investing in a mutual fund or ETF that invests in companies that are involved in the exploration, mining, or production of gold or other precious minerals, or through the direct investment in gold, platinum, or silver bullion.
The performance of precious metals funds and ETFs will be driven by the stock prices of the companies involved in the exploration, production, and development of gold and other precious metals. The stock prices will be driven by a number of factors including corporate profitability, bullion reserve levels, hedging programs, quality of management, results of exploration programs, debt levels, and the general sentiment of the equity markets. In comparison, bullion funds are designed to track the value of the underlying bullion, less fees. The price of the underlying bullion will typically trade on the supply and demand forces based on the market’s sentiment for the bullion.
Historically, the performance of precious metals funds and ETFs and the underlying bullion have been very highly correlated. However, there will be periods in time where there is no relation between the performance of bullion and the performance of the companies. In 2011 we witnessed a significant divergence in performance with the price of gold bullion increasing by more than 10%, while according to Morningstar, the precious metals fund category average dropped by 24.5%. The main reason for this divergence is that investors were flocking to gold bullion for its safe haven status in times of market uncertainty while avoiding mining companies because of their higher levels of risk and volatility.
For example, if we look at the standard deviation of returns, which is a measure of the fluctuation in the returns for a particular investment, we see that precious metals funds have been significantly more volatile than the bullion focused funds. For the five year period ending November 30, 2011 the BMG Bullion Fund (BMG 100) had a monthly standard deviation of 6.75%. In comparison, the RBC Global Precious Metals Fund (RBF 468) had a monthly standard deviation of 10%, which is significantly higher. In other words, investors are taking on more volatility risk by investing in a precious metals fund over gold bullion.
Whether to invest in bullion directly or to invest in mining stocks will be dependent on your particular needs and objectives. Investors looking for higher levels of investment return may wish to invest in precious metals funds or ETFs. Precious metals funds and ETFs offer the potential of higher returns over the long term; however, they will likely be significantly more volatile than the bullion funds.
Investors looking for some level of safe haven appeal and diversification benefits may wish to invest in the bullion directly. Bullion funds have shown low or negative levels of correlation to the major market indices, which indicates that when included in a portfolio these types of funds have the ability to help reduce overall volatility. (Correlation is a measure of how closely related the performance of two investments are. A correlation of +1 indicates that the two investments move in an identical fashion, while a correlation of -1 shows that the two investments have moved in opposite directions. A correlation of 0 indicates that there is no relationship between the two investments)
Given the significant divergence in performance witnessed in 2011, it is our expectation that precious metals funds will outperform bullion funds in 2012.
For investors who are looking for precious metals funds, our favourites include:
RBC Global Precious Metals Fund (RBF 468) – This is one of our favourite precious metals fund and it is managed by Chris Beer and Brahm Spilfogel. The fund invests in companies that are involved in the exploration, mining and production of gold, silver and platinum. The fund may also invest in gold bullion and gold certificates up to a maximum of 20%. Performance over the long term has been strong on both an absolute and risk adjusted basis. The fund has underperformed gold bullion recently as investors have preferred to hold the bullion rather than the companies. While this trend may continue in the short term, gold companies will soon show increasing profitability, which should drive gold company prices higher resulting in outperformance relative the metal.
Sentry Precious Metals Growth Fund (NCE 703) – Manager Kevin MacLean invests the fund in companies that are involved in the exploration, mining and production of gold and other precious metals. The absolute performance of this fund has consistently been at or near the top of the category. That said, the fund is more volatile than the RBC Global Precious Metals Fund and is also more expensive, with an MER of 2.72% compared with the MER on the RBC fund of 2.14%.
iShares S&P/TSX Global Gold Index Fund ETF (TSX: XGD) – For investors who are looking to minimize costs, this ETF is the best option. This ETF boasts an MER of 0.60% and is designed to replicate, on a net of fee basis, the performance of the S&P/TSX Global Gold Index. While the fees may be lower, investors would have realized better much better returns in either the RBC or Sentry funds, and given the volatility of the sector, we would recommend an actively managed product over a passive product in most market conditions.
There are a handful of mutual funds and ETFs which invest in gold, silver and platinum bullion. They include:
Claymore Gold Bullion ETF (TSX: CGL) – Because of its low cost, this is our favourite in the sector. It is an ETF that is designed to replicate the price of gold bullion less fees. Claymore hedges the currency exposure. It invests primarily in physical gold, but may also hold gold certificates. Perhaps the most attractive feature of this fund is that it boasts a low MER of 0.56%.
Sprott Gold Bullion Fund (SPR 216) – For those investors who would prefer a bullion focused mutual fund over an ETF, the Sprott Gold Bullion Fund is a great choice. It is mutual fund that invests primarily in unencumbered, fully allocated gold bullion. It may also invest in gold certificates and closed end funds of which the underlying interest is gold. Like most of the funds on this list, it is a relatively new offering which was launched in March 2009. Of the mutual fund offerings, this fund has the lowest MER, which is 1.14%. The minimum investment is $1,000.
Mackenzie Universal Gold Bullion Fund – (MFC 2989) – One of the newer entries in the category, this mutual fund was launched in January 2010. It invests primarily in gold bullion, but may also invest in silver, platinum and palladium. It may also invest in companies that are involved in the production of gold and other precious metals. As of October 31, it was 95% invested in gold bullion. This is one of the more expensive options in the category with an MER of 2.61%. The minimum investment is $500.
BMG Gold Bullion Fund (BMG 200) – The little brother to the BMG Bullion Fund, this mutual fund invests only in unencumbered, fully allocated gold bullion. The fund is prohibited from holding derivatives, futures, options or gold certificates. This is the most expensive fund in the category with an MER of 3.06% and has a minimum investment of $1,000.
BMG Bullion Fund (BMG 100) – This is the granddaddy of the bullion funds. It was launched to retail investors in March of 2002. Unlike the funds we’ve previously discussed which invest only in gold, this fund invests in an equally weighted portfolio of gold, silver, and platinum bullion. Like the Gold Bullion Fund, this fund will not invest in gold certificates, derivatives, options or futures. It is fairly expensive with an MER of 3.03% and has a minimum investment of $1,000.
Regardless of whether you invest in a precious metals fund or in a bullion fund, investors must be aware that this sector is a risky one. It is likely that there will be very high levels of month to month volatility and potentially significant swings in value. As a result, it is our suggestion that the overall exposure within a portfolio should be limited. Our typical guideline is that for the most aggressive investor’s portfolio exposure should be capped at between 10% and 15%, with much lower exposures for those investors with lower risk tolerances.
ACTIVE ETFs GAIN IN POPULARITY
By Dave Paterson, CFA
Do Active ETFs spell the end of mutual funds?
Canadian investors love their ETFs, pumping more than $6.3 billion of new money into them in the first 11 months of 2011. They offer a relatively low cost way to gain exposure to the various asset classes, the ability to buy and sell at any point during the trading day, and operate in a very transparent manner. ETFs can also be more tax efficient than mutual funds.
The initial ETFs were designed to replicate a passive market index such as the S&P/TSX Composite Index or the S&P 500. Recently, a number of actively managed ETFs have been launched. An actively managed ETF is just like a traditional mutual fund which will have a stated investment objective and be actively run by a portfolio manager.
Actively managed ETFs are still relatively new, with the first one being launched by Horizons Exchange Traded Funds in early 2009. Today, there are still only a handful of actively managed ETFs on the market. Horizons is far and away the leader in the category, currently offering 18 actively managed ETFs. Claymore has recently launched one, but beyond that, there aren’t a lot of options for investors.
Let’s do a quick comparison between the features of actively managed ETFs and traditional mutual funds.
Product Selection and Availability
There are currently only a handful of actively managed ETFs available covering the basic asset classes as well as covered call and specialty strategies. There are literally thousands of mutual funds available in Canadacovering virtually every asset class imaginable. Winner – Mutual Funds
Costs
The MER of actively managed ETFs ranges between 0.40% and 1.25% depending on the ETF under review. Mutual funds, particularly advisor sold mutual funds, will carry MERs which are higher for comparable asset classes. But in addition to the MER, an actively managed ETF will carry a commission to buy and sell, which must be factored into the total cost. The ETF will be bought or sold at the prevailing market price, which may be at a premium or a discount to the net asset value of the fund. In comparison, a mutual fund will always be bought and sold at its net asset value. Any premium or discount to the NAV must be factored in when looking at the total costs. A number of the actively managed ETFs also have performance fees similar to a hedge fund, where the manager will receive 20% of the returns in excess the fund’s benchmark. When all expenses are considered, the total cost of an actively managed ETF may not be materially different than the cost of a high quality no load fund or an F-Class advisor sold fund. Winner – Tie
Liquidity
Mutual funds are priced once per day based on the closing prices of all the securities in the portfolio. Actively managed ETFs are just like any other stock that trades on an exchange. They can be bought or sold at any time during the trading day, at the prevailing market price. Winner – Actively Managed ETFs
Portfolio Transparency
One of the key arguments in favour of an ETF over a mutual fund is that ETFs are more transparent than a mutual fund. For example, traditional passive ETFs will publish their portfolios on a daily basis. However, actively managed ETFs are not required to publish their portfolios daily. Many actively managed ETFs will publish their portfolios on a monthly basis, but they must publish their top 25 holdings on at least a quarterly basis. In comparison, mutual funds are required to publish their top 25 holdings on a quarterly basis. Winner – Actively Managed ETFs
Tax Efficiency
Another key advantage of a traditional, passive ETF is that they are more tax efficient than a mutual fund. The reason for this is that the portfolios are passively managed which results in less trading activity on an ongoing basis. Further, the managers do not need to sell securities to fund redemptions, as mutual fund managers do. But, with an actively managed ETF there is a portfolio manager who is overseeing the portfolio, virtually identical to the way a mutual fund is run. This will result in capital gains and losses for the fund, which will erode a significant portion of the tax efficiency. Once all is considered, it is not expected that there will be a meaningful difference in the tax efficiency between an actively managed ETF and a mutual fund. Winner –Tie
Performance
Actively managed ETFs have only been around since 2009. As such, there is not significant data on which to do a meaningful performance analysis. However, logic would dictate that if you’re looking at two nearly identical funds, but one has a lower cost of ownership, the lower cost fund should outperform. Based on our expectation that there will not be a meaningful cost advantage to the actively managed ETF, we do not expect there to be a significant performance premium either when compared to a similar, low cost mutual fund. Winner – Tie
Bottom Line
The key reasons that many people invest in ETFs are lower costs, simplicity, tax efficiency, and transparency. With an actively managed ETF, many of those advantages are negated.
Costs of an actively managed ETF are higher than the costs of a passively managed ETF, but are not substantially lower than a low cost mutual fund.
Employing a passive investment strategy is fairly simple. One need only determine the appropriate asset mix and purchase the ETF necessary to provide exposure to the respective asset classes. Investors like ETFs because they provide a simple way to gain access to the various asset classes. Investors know that the performance of the ETF will basically match the performance of the index, less the management fee. There is no need to do a review on the manager running the fund, the investment process, sell discipline, risk management process and historic performance. With an actively managed ETF, those factors definitely need to be considered in the same way they would be when considering a mutual fund. Therefore the process of building a portfolio with actively managed ETFs becomes considerably more involved than it is with a passive strategy.
With respect to transparency and tax efficiency, an index based passive ETF provides significantly more transparency and tax efficiency than does an actively managed ETF. When comparing an actively managed ETF to a mutual fund, there isn’t a significant difference between the two.
While we fully expect that active ETFs will continue to grow in popularity in the coming months and years, we are not convinced that they are a great investment vehicle for most investors at this point in time. It is our opinion that investors who are looking to utilize an ETF strategy are better served using the more traditional ETFs that are currently available.
For investors who are looking for actively managed investment products we feel that they would be better served by using high quality, low cost mutual funds. However, as the number of actively managed ETF product offerings grows, the more attractive they may become as a viable alternative to mutual funds.
Mutual Funds Update
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Copyright 2012 by Gordon Pape Enterprises Ltd. and Paterson & Associates
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