As one of the fastest growing segments of the already fast-growing ETF market, actively-managed ETFs could open up a whole new set of strategies - both betting on and against managers. ETFs- exchange-traded-funds- are already known as a more transparent, tax-efficient and liquid way to buy indices. They have these advantages as opposed to the commissions, spreads of trading which are now required to buy (full comparison). Increasingly, the costs are being outweighed by the benefits.
In my opinion, however, the key attribute that has led to ETFs' success is its liquidity/transparency. Like a shiny new machine in the casino, ETFs (such as DXJ) promised even faster trades and up to date pricing that make (or break) entire companies. With this in mind, will the next generation of active etfs allow for investors/speculators to hedge their managers?
The prototypical active etf is PIMCO's Total Return etf (BOND), which has done well:
(Source: http://seekingalpha.com/article/578491-pimco-total-return-etf-off-to-a-fast-start)
Notice that the etf (top-most line) is not just being compared to its benchmark (which it handily beat), but also PIMCO's own Total Return Fund. In a very real sense, Bill Gross has beaten himself. Similar to the cash-futures basis, could there be an etf-mutual fund basis?
Now let's take this a few steps further:
- Execution-hedging: If xyz investor has a large holding in a mutual fund that he wants to liquidate intraday (wanting, perhaps erroneously, to catch the top), he can short the etf until the close.
- Manager-hedging: xyz investor likes abc strategy and has invested in a top tier manager. There is another manager doing the same abc strategy but the investor believes this other manager will do significantly worse than the top tier. He/she can short the etf while still invested in the top tier manager
- "Basis" trading: If one believes that a particular manager's etf version is going to do worse or is mispriced relative to the mutual fund version, he/she can short the etf and buy the mutual fund. This is admittedly incomplete, as one cannot "short" a mutual fund easily.
This is all conjecture- but what if it were possible to hedge the LTCM/Harbinger/Paulson-like exposure to your portfolio?
(icon source: http://optionalpha.com/how-to-diversify-your-portfolio-with-a-single-et…)
I think that within 20 years, we might see a fairly active options market on big funds in the OTC market. The problem now is that the banks need to invest in the funds to hedge their exposure, which are highly illiquid (referring to 3c-7 funds, not mutual funds) and these assets get level 3 capital treatment. If it was a two way market instead of them just selling call options to high net worth investors, it would work a lot better. Unfortunately, any tax benefit of investing in options on funds will likely be eliminated if these options become remotely popular.
Interesting! Insane hedge costs makes sense given underlying fund lockups and the need to "delta" hedge. I'm reminded of funds such as Third Point's offshore fund (which publishes weekly nav) with an active secondary market. I wonder how many investors bought otc calls on those, hmmm.
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