PowerShares Capital Management has caught attention by announcing that they are the first exchange-traded fund (ETF) provider to receive exceptive relief from the U.S. Securities and Exchange Commission for actively managed ETFs in registration.  

>>> more about PowerShares initial filing ( December 12, 2007)

The PowerShares press release states that their four active ETFs will provide investors with access to active management in an ETF structure. The four ETFs are:

--PowerShares Active AlphaQ Fund
--PowerShares Active Alpha Multi-Cap Fund
--PowerShares Active Mega-Cap Portfolio
--PowerShares Active Low Duration Portfolio

How will the launch of these new “actively managed” ETFs affect individual investors and the ETF market place?

To assess the future effect of actively managed ETFs we first have define the meaning of “actively managed” in connection with the above ETFs. Granted, the new PowerShares ETFs are the first that do not follow an index, but does that mean they closely resemble actively managed mutual funds?

To further understand the new line-up, lets take a look “under the hood” of the newly approved ETFs and compare them with PowerShares current line-up.

Stocks for two the new Active Alpha ETFs are selected based on a quantitative selection methodology called “NOW” ranking, developed by AER Advisors, a New Hampshire-based investment researcher. The system combines aspects of stock money flow with traditional security analysis.

This calls to mind PowerShares existing lineup of Dynamic ETFs, which are based on Intellidex indexes managed by the American Stock Exchange. Interestingly, both fund lineups use proprietary quantitative ranking systems for selecting securities. One difference is that the methodology for determining the final score is more transparent for the AER driven portfolios.

Thus the two Active Alpha ETFs are more quantitatively selected stock portfolios that actively managed portfolios. The Active Mega-Cap goes a step further as the management will have more room to apply judgment within the quantitative selection model but is subject to disclosing its holdings each day.

While for right now actively managed ETFs essentially deliver mechanic and quant based stock selection, PowerShares has started a trend that might quickly evolve into a more traditional active management style. Barclays Global and State Street Global have followed suit and filed for their own actively managed ETFs.

Once truly actively managed ETFs hit the market place, the real concern to investors will be  track record (or lack thereof). New actively managed ETFs will lack a performance history and will require investors to take a leap of faith based on very little information. It will take years to build a performance track record.

Even the track record of established mutual funds shows that up to 90% of actively mutual funds (over a 10-year period) under-perform their corresponding benchmark (indexes and index based products). Actively managed ETFs will likely face the same issue.

Pros and Cons of actively managed ETFs     

Interestingly, actively managed ETFs might not be what investors are looking for. Owen Concannon, an analyst for Financial Research Corp said that investment sentiment has turned towards more passive investment vehicles. While actively managed mutual funds still hold 84% of the market at the end of last year first time ever, passively managed funds garnered more than half of the industry's net inflow during a single year since FRC started collecting such data.

Some $31 billion of last year's $142 billion net inflow into ETFs went to ONE single fund, the original SPDRs (Ticker: SPY), which follow the ever popular S&P 500. Put another way, the ETF marketplace is very concentrated and the 10 biggest ETFs represent about 46% of the industry's asset base, which seems to indicate that new ETFs will have a harder time gathering significant assets. Ultimately, it will be investors that decide whether actively managed ETFs will be a hit.

Simon Maierhofer is the Portfolio Strategist for three of ETFguide’s Ready-To-Go Portfolios all of which have outperformed the S&P 500 in 2007 and are outperforming on a year-to-date basis thru the end of February. Ready-To-Go Portfolios provide the investments ideas and asset allocation needed to succeed through all types of market cycles.

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