The evolution of the exchange‐traded fund: is active management on the horizon?

Abstract

Purpose -To discuss how product innovations in exchange-traded funds (ETFs) have blurred the line between passive and active management, and to explore the legal ramifications of these developments.Design/methodology/approach -Describes how ETFs operate and how the ETF marketplace has grown; discusses the use of broad-based indexes for most ETFs until recently; describes newer ETFs that provide targeted exposure to narrow market segments; and discusses underlying indexes that are based on performance-based characteristics rather than market segments, along with possible difficulties in making performance-based criteria widely available to investors.Findings -Historically the SEC has expressed skepticism over actively managed ETFs because of uncertainty as to whether they can provide the same portfolio transparency and arbitrage opportunity that traditional ETFs can. As ''Rule Sets,'' or criteria for including companies in performance indexes, become more involved and less objective, the challenge will be to ensure that sufficient arbitrage opportunities exist to ensure pricing efficiency. If that challenge can be met, it may serve as a model for a truly actively managed ETF.Originality/value -Explains how the new generation of ETFs is coming closer to the line of active management and the legal issues that must be surmounted before truly actively managed ETFs are offered. KeywordsInvestments, Unit trusts Paper type Technical I n 2001, the Securities and Exchange Commission published a concept release outlining the regulatory challenges associated with an actively-managed exchange traded fund. Almost five years and $200 billion dollars in assets under management later, the ETF industry has continued to evolve and product innovations have moved the industry closer and closer to the line of active management. If this development continues, it could very well revolutionize the investment management industry.

Exchange traded funds in Europe and the US

“…Investors trading ETFs can examine the exact assets and liabilities of the fund at any time. NAV is extremely useful as it provides investors a reference point around which they can gauge any offers to buy or sell shares 22 NAV is typically calculated only once a day (Rosella and Pugliese, 2006).…”