IShares tests the waters for active ETFs

April 7, 2013 4:13 am

IShares tests the waters for active ETFs

By Jackie Noblett

IShares registered the launch of two active US equity products last Monday, the latest test of the waters for the world’s largest exchange traded fund company.

The US house unveiled plans for the iShares Enhanced US Large Cap ETF and the iShares Enhanced Small Cap ETF.

It is the latest attempt by iShares to register active ETFs. But, like other fund companies to have registered funds, including Legg Mason and Federated, iShares has yet to go live with any of those products.

Analysts believe, however, that a number of active ETFs will come to the market this year.While the newly registered iShares products would not track an index, the portfolio would be assembled based on quantitative investment characteristics such as earnings variability, leverage, price-to-book ratio and market capitalisation.

In 2011, the US house unveiled plans for a series of “strategic beta” active ETFs that would cover various segments of the domestic and international equity markets.

The large- and small-cap products registered last week have mostly similar principal investment strategies, but different fund names for the strategic beta products.

IShares has placed a number of active products into registration in recent years, including quasi-active equities, currencies, short-duration bonds and, most recently, a corporate bond ETF.

While there have been some notable successes, including the $4.6bn Pimco Total Return ETF, active ETFs still remain a minuscule portion of total ETF assets.

Active equity products have proved difficult to launch as asset managers question whether such products can succeed under full portfolio transparency.

In the face of those challenges, iShares is among several asset managers that have yet to act on the active ETFs they have registered.

Some existing ETF sponsors, such as State Street Global Advisors and Columbia Management, are working their way through the unique regulatory process for active ETFs.

Industry observers say some fund companies may be choosing to register products in order to have a seat at the table with the Securities and Exchange Commission in the future of active ETF regulation. But they do expect some houses to break into the market at some point this year.

Indeed, 57 per cent of ETF sponsors interviewed by Cerulli Associates, the fund consultancy, earlier this year said they planned to develop active fixed income ETFs. Roughly 37 per cent of sponsors planned to develop active equity ETFs.

“Firms saw what Pimco did in the fixed income space and are looking to move on it,” says Alec Papazian, associate director at Cerulli.

While he does not expect many firms to launch fully active domestic equity ETFs, products such as those proposed by iShares fit into a trend of more enhanced beta development, either in an index or active format, he says.

The regulatory review period for would-be active ETF sponsors is known to be long.

First is the exemptive relief process, which at one time took a year or more to complete. Individual active products are then subject to review by the SEC division of trading and markets, which can take several months.

Some firms have used that time period between filing and receiving approval to hone and refine the business case behind developing ETFs.

In many ways, those companies use the filings as placeholders for when they are ready to get into ETFs, if at all, people close to the situation say.

Similarly, a product registration statement can be used as a trial balloon to gauge how regulators may react to a given product’s investment strategy or structure, says Larry
Petrone, director of research at Kasina, a consultancy firm.

“There’s a lot of probing out there with the SEC, what are they willing to do, where are they willing to go,” he says.

Mr Petrone points to the filing of iShares’ parent, BlackRock, with the SEC in September 2011 to launch non-transparent active ETFs using a blind trust to facilitate creations and redemptions.

But the level of detail in the iShares filing this week indicates the products are closer to launching than other active filings.

The registration statements are not dated but they do provide tickers
and expense information, which are not usually added until the product nears launch.

The large-cap ETF will charge 18 basis points in fees and the small-cap ETF will charge 35bp.