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It took more than a decade of negotiating to get Securities and Exchange Commission approval, but actively managed exchange-traded funds (ETFs) finally came to market this year. Although the new funds operate under strict transparency requirements and trading rules, they are so new, and as yet, so few, it's hard to assess their usefulness and how they are likely to fare as an investment option.
The first active ETFs went public in early March, and so far there are only 11 of them, although all major ETF providers claim to have their own versions of the product in the pipeline.
A sample of the new offerings comes from Invesco PowerShares, which recently introduced four actively managed products, a fixed-income fund and three equity funds (see table on page 26). Two of those funds, Active Alpha Q and the Active Alpha Multi-Cap are structured in a way that's fairly typical of actively managed funds. Each one invests in 50 companies drawn from specific universes of stocks. The Active Alpha Q Fund invests in the largest 100 companies, by market share, on the Nasdaq. The Active Alpha Multi-Cap Fund selects from the 2,000 largest publicly traded companies.
"Stock selection is driven by companies with strong earnings growth, low valuation relative to growth and positive money flow," says David O'Leary, chairman and chief investment officer of AER Advisors and portfolio manager for the two funds. "The key to producing solid alpha is focusing the portfolios on companies with strong buy pressure, where investors are attracted to the stocks because of the earnings growth and price/earnings multiple. Over time, alpha is produced by exposing the portfolio to rapid earnings growth, the potential rising valuation of the chosen stocks and high liquidity in terms of the trading volume."
FINDING ALPHA
UNDER THE FUNDS' RULES, O'LEARY CAN CHANGE UP TO THREE POSITIONS PER WEEK. THIS MAKES THE FUNDS MORE FLEXIBLE THAN TRADITIONAL INDEX-BASED ETFS. "THE UNIVERSE IS UPDATED WEEKLY AS MARKET CAPS CHANGE AND WE ADD IPOS AFTER THEY HAVE TRADED FOR FOUR WEEKS," HE SAYS. "THIS GIVES US AN ADVANTAGE OVER THE BENCHMARKS THAT TEND TO PICK UP NEW STOCKS AFTER 12 MONTHS, AND COMPANIES, SUCH AS GOOGLE, CAN RISE SIGNIFICANTLY BEFORE THEY ARE ADDED TO THE INDEX. CONVERSELY,...