Actively managed ETFs

Actively managed exchange-traded funds (ETFs) have come to Canada. There are now nine listed on the Toronto Stock Exchange. A quick overview of the group is available in my blog post “Actively managed ETFs in Canada.”

The initial reaction, on balance, has not been overly positive. Most users of ETFs are passive investors and don’t believe in stock-picking or professional money managers. So their aversion is perhaps understandable.

My initial reaction was similar. Another case of some financial innovator taking the exchange-traded fund (ETF) concept too far, it seemed. But now, after some further thought, I wonder if we are perhaps being too hasty in dismissing them.

The reason the majority of active investors underperform the market is not necessarily because of their stock-picking skills — it has a lot to do with costs. This is particularly so in the case of actively managed equity mutual funds, where management expense ratios (MERs) average about 2.4% a year. That’s a high hurdle to clear.

Most of the actively managed ETFs have much lower MERs, in the range of 0.70% to 0.75%. As such, the hurdles are a lot lower for their active investing strategies. More of the talented and harder-working ones should finish ahead of the index.

Furthermore, many of the actively managed ETFs reward portfolio managers with 20% of the returns above the market index. These funds are clearly pursuing the strategy of letting the track record do the marketing. The managers are not hugging the index and letting the marketing department bring in the customers.

One of the actively managed ETFs I confess to being interested in is the Horizons AlphaPro Managed S&P/TSX 60 ETF, which trades under the symbol HAX. It was launched in January 2009 under technical analyst Ron Meisels; he recently gave up the reins to the investment managers at Front Street Investment Management in Toronto.

The firm’s co-chief investment officer, Frank Mersch, has outperformed the S&P/TSX Composite Index in18 of the last 21 years.  First, it was as manager of the Altamira Equity Fund from 1988 to 1997, where he earned a compound average growth rate (CAGR) of 20% against the S&P/TSX Composite Index’s 9.5%. Then, from 1999 to present, he managed the Front Street Canadian Hedge Fund to a CAGR of 14.6% versus 4.8% for the Composite.

The other co-chief investment officer at Front Street Investment, Norm Lamarche, has a superb track record as well. Front Street’s Web site plays up his 2006 mention in the Globe and Mail as the “best mutual fund manager you’ve never heard of” and notes that, according to GlobeFund.com, he has managed the No. 1 and No. 2 funds in Canada over the last 15 years based on the 15-year average compound return of the funds.

So, I have to admit that next time the opportunity comes along to increase exposure to Canadian equities, I would be rather tempted to add the Horizons AlphaPro Managed S&P/TSX 60 ETF to the passive ETFs already tracking Canadian equities in the portfolio.

I realize this article won’t get too many 4- or 5-star ratings from dyed-in-the-wool passive investors! But if that’s the price for saying what one thinks, then that’s the way it’s got to be.

Gordon Pape does provide a caveat. In his Internet Wealth Builder publication, he says Mersch’s and Lamarche’s “best performances have been delivered by small-cap resource stocks [and the HAX] focuses on the large-cap stocks that make up the TSX 60 index.”