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January 29, 2007 8:48 pm

Investment vehicle could be a ‘better mousetrap’ for managers

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What’s the big deal about actively managed ETFs? It is not as though mutual fund managers always beat the market anyway.

It is a valid point. After all, there is a wealth of research that shows that most fund managers running open-end mutual funds generally do not outperform the Standard & Poor’s 500 index.

But, according to a new study, fund managers have been given short shrift. The study found that when mutual fund managers buy stocks for informational reasons, those stocks outperform their benchmarks by almost 3 per cent a year, but when managers buy for liquidity reasons, there is no outperformance.

The study, which analysed 1,400 actively managed open-end mutual funds from 1980 to 2003, examined instances when fund managers aggressively bought during times when fund investors were cashing out.

“When that happens, managers were probably buying for valuation reasons,” says Scott Gibson, a finance professor at the College of William and Mary Mason School of Business, who co-authored the study.

But, when money was pouring into a fund, and Prof Gibson observed managers making a number of small buys, “the chances are they were working off that excess cash, and making liquidity-motivated buys. Similarly, on the sell side, if money is pouring into a fund, and they’re selling a stock aggressively, chances are they no longer like the stocks.

“The bottom line is that mutual fund managers can pick stocks,” Prof Gibson says.

“The problem is that the structure they operate under, specifically the need to rebalance portfolios in response to investor flows, acts as a drag on performance.”

Could an active ETF change that? Quite possibly, according to Prof Gibson.

He says that because ETFs differ from open-end funds in that exchanges are settled not for cash but rather in-kind for pro rata stakes in the underlying stocks, ETF managers never need either to sell stocks to raise cash or buy stocks to work off excess cash.

Actively managed ETFs appear to be a “better mousetrap”, Prof Gibson says.

“If you can free up managers from having to make forced liquidity trades, our research shows they can beat the market.”

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