Game On: Mutual Funds vs. ETFs

Grail Advisors has launched the first, true actively managed equity exchange-traded fund. There have been other ETFs that have claimed to be actively managed, but Grail is the first to use managers who don’t track an index and/or use a quantitatively–driven process. In other words, the managers of the new ETF will pick stocks the old-fashioned way (true stock picking) and not with computer models.

There has been debate whether or not the ETF structure is active-management friendly. Under the ETF structure, Grail must publish the ETF’s stock holdings on a daily basis. Mutual fund managers are required to report their holdings less frequently (quarterly and lagging) so they don’t give away their stock picks for free. Mutual fund managers argue that if the fund reports holdings daily, investors have the opportunity to follow the strategy in their own portfolio (receiving the benefit of the fund manager’s work without paying the fund manager).

While mutual fund managers argue for less transparency, ETF backers are showing all their cards. If the actively managed ETF structure proves to be a winner, it will add further fuel to the ETF backers’ fire. Those on the ETF bandwagon have long argued that the benefits of ETFs outweigh the benefits of mutual funds.

I am in the camp that is critical of some dogmatic ETF pushers as not seeing the big picture. Why does a long-term investor care if they buy an ETF at any point in the trading day or a mutual fund at 4pm (mutual fund trades are executed at the close of the trading day). What’s a couple of hours if the investor plans to hold the fund for years? Better yet, I haven’t found anyone that can time the market’s swings down to the minute (or daily, weekly, monthly, etc.). I believe that if the ETF camp compares index mutual funds to index ETFs (versus arguing against all actively managed funds) their argument is weakened (for long-term individual investors).

There are many more points to the argument that go beyond this post, but suffice it say that if actively managed ETFs succeed, I do believe it is a game changer. The tax benefits of ETFs may prove to be more convincing. With actively managed ETFs, we can now compare active ETFs versus active mutual funds and index ETFs with index mutual funds. Check back for more on this issue in future posts.