Grail Floats 4 Actively Managed ETFs

• Trang Ho
• On 5:25 pm EDT, Monday October 12, 2009

Lack of interest in its first ETF hasn't deterred Grail Advisors from adding more funds to its lineup.

The fledging ETF provider this month launched four "actively managed" ETFs based on old-fashioned stock picking rather than indexes.

RP Growth ETF (NYSEArca:RPX - News): This 72-stock fund buys mainly U.S. stocks of any market cap.

"RP uses a fundamental research driven approach to identifying those industries and companies with the strongest growth prospects for revenue, earnings and/or cash flow over the medium and long term and seeks to buy stock in those companies at attractive valuations," states the prospectus.

RP Focused Large Cap Growth ETF (NYSEArca:RWG - News): This fund holds 20 to 30 "highest conviction ideas" with market caps of at least $5 billion. Wedgewood, the subadviser, "seeks investments in market leaders with dominant products or services that are irreplaceable or lack substitutes."

It screens for "above-average returns on equity, returns on capital, cash flow returns on investment, earnings per share growth and revenue growth." It can hold a stock more than five years.

RP Technology ETF (NYSEArca:RPQ - News) and RP Financials ETF (NYSEArca:RFF - News): Both sector funds target mid- to large-cap stocks with capitalizations of $2 billion to $150 billion. The investment thesis is the same for both: Buy companies benefiting from "sustainable competitive advantages, barriers to entry, technological innovation, changes in government regulation and demographic trends."

With the exception of RP Financials, which is team managed, Grail's selling point 19 that the new ETFs are the first to be managed by a single manager. Its first actively managed ETF launched in May, Grail American Beacon Large Cap Value (NYSEArca:GVT - News) is run by several managers.

Each of the new funds can go 100% into cash for "temporary defensive purposes." They carry an expense ratio of 0.89%.

If the market receives these like other actively managed funds such as PowerShares Active Mega Cap Fund (NYSEArca:PMA - News), PowerShares Active AlphaQ Fund (NYSEArca:PQY - News) and PowerShares Active Alpha Multi Cap Fund (NYSEArca:PQZ - News), which have been trading for a year and a half, volume may be nil most days.

Investment Strategy

RiverPark's "deep value discipline" and "research-driven fundamental investing" plan involves bottom-up stock picking and buying low and selling high.

"On a day when stocks are down, we may be buying," said Mitch Rubin, who manages RP Growth. The chief investment officer and founding partner of RiverPark Capital formerly co-managed Baron Growth (NASDAQ:BGRFX - News), Baron iOpportunity (NASDAQ:BIOPX - News) and Baron Fifth Avenue Growth Fund (NASDAQ:BFTHX - News).

The qualitative and quantitative research involved both art and science, he says.

As a rule, Rubin looks for companies that "will generate at least 20% of their current total enterprise value in excess cash over the next five years," cash flow per share growth of at least 10% a year and revenue growth of 5%, preferably 10%, a year. Overall, the company must have the potential to double or triple profits over the next three to five years.

Rubin then screens for companies generating excess cash, allowing them to pay down debt, buy back shares or reinvest in the business.

His qualitative research process involves talking to a company's customers, suppliers and competitors, visiting companies, vetting management, building financial models and forecasting future cash flow.

Investment advisers are less than impressed with the new funds, as existing actively managed ETFs have failed to attract assets.

"While you have experienced money managers, you have to determine over time if it works," said Jim Farrish, founder of SectorExchange.com. "I wouldn't want to be the first one in the fund."

Big Spreads?

Grail's ETFs should share the same qualities as other ETFs, but low trading volume would mean wide bid-ask spreads, says Gary Gordon, president of Pacific Park Financial. They may or may not benefit from transparency in their holdings. And they likely won't be tax efficient because of frequent trading.

Grail has registered two new actively managed fixed-income ETFs: Grail McDonnell Intermediate Municipal Bond ETF and Grail McDonnell Core Taxable Bond ETF. Both will be subadvised by fixed-income specialist McDonnell Investment Management.

These would compete with thinly traded PowerShares Active Low Duration Fund (NYSEArca:PLK - News), another actively managed fixed-income ETF that buys government, corporate and agency debt.

Grail plans to float 24 to 30 active ETFs in the next year or so.

Buzz up!