The vast majority of the more than $1.2 trillion in ETF assets are in passive, indexed strategies. But that hasn't deterred AdvisorShares Chief Executive Officer Noah Hamman from leading the charge to define a more active future in the world of exchange-traded funds. His firm helps active managers bring their strategies to market in ETF wrappers, and his biggest fund, the AdvisorShares Active Bear ETF (HDGE), has $326 million in assets, or just over half of all the assets to his firm's name.
In an interview with IndexUniverse Correspondent Cinthia Murphy, Hamman acknowledged that market development for active ETFs has so far been a tough row to hoe, but said the same was true for index ETFs in the early years. He argued that most mutual fund assets remain in active strategies, and because investors want alpha, a lot of those assets stand a decent chance of migrating into active ETFs.
Murphy :I have been told recently that the next wave of growth in the ETF industry will not come as much from 401(k)s as from a boom in actively managed strategies. I assume you would be in that camp, right?
Hamman :The majority of investor assets in equities mutual funds—something like 80 percent, last time I checked—is tied to actively managed strategies. It's a really big number. It's investors voting with their dollars to say they want active management. So we look at that and we see the potential. But it's a slow process to tap into that demand.
Murphy :For an active ETF provider like AdvisorShares, then, the competition is mutual funds rather than index-fund firms?
Hamman :I often get that question:"How are you going to compete with iShares, PowerShares, SSgA?" And I always answer it the same way:We are not competing against those guys. We are competing with actively managed mutual funds.
Murphy :So an active ETF should not be seen as a replacement for a passive strategy, but rather a complement to it in an overall portfolio?
Hamman :Investors really need a balance between asset class diversification and manager diversification. You go out and get exposure to an asset class either broadly or granularly through an index-based strategy. When you see an index ETF, you automatically know whether you want that beta exposure or not. But in an active fund, you look at a manager's track record and you choose whether to add that to your mix or not.
Murphy :Meaning, ideally investors would own, say, (SPY) and then add various active funds to complement and/or hedge their positions?
Hamman :Definitely. With active management, you might want different management approaches to a certain exposure, like one manager who focuses on fundamentals, one who is keen on technicals, etc. In the end, it's all about getting manager-style diversification on top of your asset class diversification.
Murphy :If the potential is this great, why are so many actively managed ETFs struggling to stay afloat?
Hamman :To put this into perspective, if you look at the first four years of index-based strategies—ETFs first came to be in 1993—and look at the first four years of active management, with the first actively managed ETF coming to market in 2008, you will see that active funds have gathered far more assets and launched far more products in that same time frame. On a relative basis, active ETFs have taken off to a great start.
Murphy :But one could argue that active ETFs are entering a well-established marketplace already where index funds had to blaze a new trail.
Hamman :I have to give credit to index ETFs for laying the groundwork, no doubt. But conversely, I can also say that the early ETFs were very institutional-focused, they were big-ticket items. Active ETFs are largely not for institutions right now; they have tended to target the smaller, retail investor, so it been harder to accumulate assets because they are smaller ticket items. I do believe institutional will use active ETFs, but it will definitely take some time and growth.
Charts courtesy of AdvisorShares
Murphy :It's perhaps unsurprising that in the current economic environment investors have been so focused on costs, but pricing of active ETFs is clearly an issue, isn't it?
Hamman :Pricing is a challenging element for us. Active management costs more because you have to pay for that manager. Is it worth it? Well, if they don't perform well, you can argue that it isn't. But if they do, then you can argue that it is. That's the case of just about everything in life. It's unfair to compare our costs to those of index ETFs—they don't have active managers, so in that sense, I don't get the price fixation in this space, but I understand the importance of building a team of solid managers, because that's what makes a difference.
Take AADR, for example--AdvisorShares' WMC/BNY Mellon Focused Growth ADR ETF (AADR)--it brings institutional management to the MSCI EAFE space. They're 'killing it!' Their performance is like 800 basis points above the index since inception, at around 13 percent.
The iShares index-based equivalent, iShares MSCI EAFE Index Fund (EFA), has returned just over 5.2 percent since AADR came to market. And even if you look at the iShares' MSCI EAFE Growth Index Fund (EFG)—which you could argue is a better comparison to AADR's heavy focus on growth—that has returned 8 percent. You will pay more for AADR, but you will still be getting higher returns— even net fees. So, the performance is there, but getting the word out is another thing.
Murphy :Let's talk about your single most popular fund, the Active Bear ETF (HDGE). Half of your assets are tied to that one ETF. What has made that particular strategy resonate with investors, particularly given that it's given up about 5.5 percent in value year-to-date?
Hamman :HDGE is just so unique, there's really nothing like it in the ETF space or even a really comparable strategy in the mutual fund space. It's all short—no leverage, no derivatives, just a truly short fund. A lot of investors have been moving away from leverage and derivatives with all the negative publicity around the risks involved with that, and our strategy is something you can hold for a longer time, even in a bull market because some equities will still go down in bull markets.
The way it's designed, it picks companies that struggle the most in a down market, and those tend to lose more than the broad stock market. In an up market, it picks the struggling companies at that time, who will benefit from broad stock market strength, but will still struggle. It's a balance. And one that has outperformed other funds, like the ProShares single beta Short S'P 500 (SH) by as many as 1,000 basis points. So, yes, it's down year-to-date, but it has done very well relative to other strategies.
Murphy :What's next for AdvisorShares? Where are the untapped opportunities in the active management space?
Hamman :We have an equity hedge strategy coming up that uses hedge-fund replication techniques through factor analysis of hedge funds' track records. We look at performance returns and extract the strategies behind them. But we will do that in an active way rather than by passively copying what hedge fund managers are doing based on 13F regulatory filings like Global X's (GURU), for instance. Passively trading on stale data from active managers seems like a strange notion, but there are statistics that say waiting that time frame for the filings doesn't matter that much. It's hard to argue against data. But I think that's an area where active management makes a lot of sense.
We also have an asset allocation fund with an options strategy around it that is designed to produce income scheduled for launch in September.
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