Axel Merk, the macro investor known for his expertise in currencies, is part of a plan to bring to market an ETF version of the dollar-bearish Merk Hard Currency Fund he manages—a move that’s reminiscent of how Pimco decided to market the flagship Total Return Fund run by Bill Gross in an ETF wrapper.
The Merk Hard Currency ETF will also be managed by Merk, a German-born investment manager who is president of Palo Alto, Calif.-based Merk Investment LLC. The Merk Hard Currency Fund, his firm’s biggest portfolio, is a nearly seven-year-old actively managed open-ended mutual fund with almost $600 million in assets.
The ETF will normally invest 80 percent of its net assets in hard-currency-denominated investments from countries that appear conducive to long-term price stability, according to regulatory paperwork filed with the Securities and Exchange Commission on March 21. Its investments will be composed of high-quality short-term debt instruments, including sovereign debt and gold.
The new ETF, which will trade on the New York Stock Exchange’s electronic trading platform Arca under the symbol “HRD,” is being shepherded through the regulatory process by Portland, Maine-based Forum Investment Advisors, which is in the process of obtaining “exemptive relief” to market active ETF strategies.
Forum filed for the permission from the SEC last summer , and it's unlikely it would put HRD into registration unless it was close to obtaining exemptive relief.
Forum itself is part of Atlantic Fund Services, which provides custodial and record-keeping services. The prospectus said Foreside Fund Services will be the ETF’s main underwriter and distributor. Forum and the other entities all have the same Portland, Maine address.
The ETF industry was abuzz as TRXT came to market March 1, which provided a clue as to how Pimco would preserve the cache of its $250 billion Total Return Fund, the world’s biggest mutual fund. While Merk’s currency fund is considerably smaller than the Total Return Fund, it’s move and Pimco’s are the clearest signal yet of how the numerous mutual fund companies that are seeking regulatory permission to market ETFs will approach the ETF market.
The moves suggest that established mutual fund companies are eager to jump onto the ETF bandwagon, but with products that already have clear reputations in the world of investing. By launching ETF versions of such marquee-name funds, Pimco and now Merk may be running the risk of cannibalizing assets from their respective mutual funds, but at least they’ve put in place a mechanism that keeps those assets in-house.
But, crucially, they seem to understand the growing importance of ETFs, which are extolled for their low costs and intraday tradability. The first ETF was launched 19 years ago, and U.S-listed ETF assets now total $1.209 trillion in more than 1,400 securities, according to data compiled by IndexUniverse.
The existing Merk Hard Currency Fund (MERKX) comes with a hefty 1.30 percent annual management fee, and the prospectus outlining the proposed ETF didn’t say how much HRD might cost. But if Pimco’s example is any guide, HRD will be a lot cheaper than the Hard Curreency mutual fund.
Pimco’s TRXT costs 0.55 percent, or 30 basis points cheaper than the “A” class mutual fund version that’s most appropriate for retail investors. Institutional investors to get that fee down to a no-load 46 basis points. The institutional version of the Hard Currency Fund (MHCIX) costs 1.05 percent, according to Merk Investments’ website.
Officials at Merk Investments declined to elaborate on the filing—a function of the so-called quiet period the SEC imposes when a fund is in the registration process.
A Brighter Future For Active ETFs?
A big question looming over the launch of Pimco’s TRXT and Merk’s plan to bring the ETF “HRD” to market is whether such high-profile moves will breathe life into the relatively undeveloped world of active ETFs. The vast majority—as in 99.6 percent—of ETF assets are in indexed strategies, according to data compiled by IndexUniverse. A total of $5.2 billion is invested in about 40 active funds.
The percentage looks a bit more promising—just shy of 2 percent—if the comparison is confined to fixed-income ETFs. Indeed, the two biggest active ETFs—the Pimco Enhanced Short Maturity Strategy ETF (NYSEArca:MINT - News) and the WisdomTree Emerging Markets Local Debt Fund (NYSEArca:ELD - News) are focused on fixed income. MINT and ELD have $1.42 billion $1.22 billion in assets, respectively.
When Pimco’s TRXT came to market, a number of ETF industry sources predicted that TRXT would quickly overtake MINT and ELD and quite possibly jump-start the whole active ETF space. TRXT, which was launched with $100 million in seed capital, now has a total of $224.9 million in assets.
What's more, the percentage of active-to-passive ETF assets looks even more promising in the realm of currency funds—the very world in which Axel Merk has been making his mark.
A total of $890 million, or 15 percent of the $5.97 billion invested in currency ETFs, is in active strategies. Two of the biggest funds in that space are the WisdomTree Dreyfus Emerging Currency ETF (NYSEArca:CEW - News) and the WisdomTree Dreyfus Chinese Yuan ETF (NYSEArca:CYB - News), which had $341 million and $495.3 million in assets as of March 21, respectively, according to data compiled by IndexUniverse.
Axel Merk will determine currency allocations based upon analysis of monetary policies pursued by central banks, and will also take into consideration economic environments, according to the prospectus.
The fund, benefiting from what many analysts consider a secular decline in the dollar, has had several years with double-digit returns.
But in 2011, it lost 0.77 percent. Last year, investors rushed to dollar-denominated assets— notably Treasurys —amid heightened macroeconomic concern following Standard ' Poor’s downgrade of U.S. debt and widespread doubt that eurozone policymakers would be capable of bringing the continent’s debt crisis under control.
To try to reduce interest-rate and credit risk to its portfolio, the ETF will typically maintain a weighted average portfolio maturity of less than 18 months. Also, the fund will only buy money-market or other short-term debt instruments that are issued by entities with an outstanding unsecured debt issue rated in the top three ratings by U.S. nationally recognized ratings services or that Merk considers comparable in quality to instruments rated in the top three ratings.
The paperwork also said that to the extent that the fund invests in gold, it won’t buy actual bullion. Rather, it may get its gold exposure indirectly through exchange-traded products, which could include ETPs sponsored by Merk or its affiliates.
Because the ETF is a hard currency fund, its investment strategy may require it to execute redemptions, in whole or in part, for cash. As a result, it may pay out higher annual capital gain distributions than if the in-kind redemption process was used exclusively.
In addition, changes in currency exchange rates could affect the U.S. dollar value of the ETF’s investments including foreign securities, forward-currency contracts and cross-currency forwards, the prospectus said.
It wasn’t immediately clear how the ETF version of the Hard Currency Fund might differ from the mutual fund.
Additional reporting by IndexUniverse ETF Analyst Gene Koyfman
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