State Street Corp., a leading exchange-traded fund provider, believes the much-hyped idea of actively managed ETFs remains promising but is not quite ready to take off, a senior executive says.
The first actively managed exchange-traded fund was introduced last week by Bear, Stearns & Co., but it only sets the modest goal of outperforming money market funds. Exchange-traded funds that are built to compete with more aggressive kinds of investments remain in regulatory limbo for the moment, according to James Ross, the senior managing director at State Street Global Advisors, the investment management arm of State Street Corp. in Boston.
"Over the years, the concept has been to take active mutual funds and make them exchange-traded," said Mr. Ross, whose company started the first exchange-traded fund 15 years ago. "That's not where we're at with the initial active ETFs."
Active ETFs are designed to deliver the range of returns that mutual funds do, with lower fees, more flexibility, and smaller tax consequences, rather than merely track a market index.
State Street plans to enter the actively managed exchange-traded fund field this year, Mr. Ross said in an interview, and other companies are lined up to do the same.
But the Securities and Exchange Commission has insisted that such funds have the same transparency as stocks. Bear Stearns' Current Yield Fund complies by revealing all of its holdings daily and updating its price every 15 minutes.
Mr. Ross said that fund sponsors ultimately want the ability to keep their holdings temporarily secret, as mutual funds do, so that investors cannot duplicate the managers' strategies.
The conflicting agendas, he said, mean that "we are still a long way from having a true nondisclosed fundamental equity fund traded on an exchange." He declined to offer details of State Street's proposed actively managed, exchange-traded fund, citing legal concerns.
Bear Stearns' Current Yield Fund began trading on the American Stock Exchange March 25. It comprises short-term, fixed-income instruments and aims to generate higher returns than a money market fund, according to Bear.
George Simon, a partner in Foley & Lardner LLP, a Chicago law firm, said an exchange-traded fund that inches closer to sponsors' ultimate goal could come within a few months. "My hope is that you will have a less than fully transparent fund approved within this calendar year," he said. His firm worked with Bear Stearns to bring its fund to market.
"You have to walk before you can run," said Mr. Simon's colleague Patrick Daugherty, a Foley & Lardner partner.
Actively managed exchange-traded funds are one example of how the business has changed since 1993, when State Street unveiled the first exchange-traded portfolio, the SPDR Trust, which tracks the S&P 500 index.
The Boston company has more competition than ever. According to a State Street report, the global investors unit of Barclays PLC has about half the ETF market share, double State Street's one-quarter. State Street's share, however, is more than three times that of its nearest rival.
The number of ETF sponsors and portfolios keeps expanding. Last year, 270 exchange-traded funds were started, for a total of 629. Just 56 of them were from Barclays and State Street. ProFunds Advisors LLC, started 46 funds; XShares Advisors LLC of New York, 31; and PowerShares Capital Management LLC of Chicago, 28. The scope of exchange-traded fund portfolios has grown ever narrower, meanwhile.
Competition does not faze State Street, Mr. Ross said. Most new assets is going to more established funds, he said. State Street research said that Barclays got 42.5% and State Street 30% of the $188 billion in asset growth last year. The attention generated by the newcomers and their new products is in the "long-term good for business," Mr. Ross said.
State Street introduced 22 exchange-traded funds last year, bringing its total to 65. On March 19, it started a fund that invests in international government inflation-protected securities designed to let investors hedge against inflation and the weak U.S. dollar.
State Street has more exchange-traded funds in the works, Mr. Ross said. Fixed-income exchange-traded funds are heavily outnumbered industrywide by those built around equities, and State Street sees an opportunity to create more bond exchange-traded funds, he said. "We think there is development available all over our fixed-income spectrum," he said.
