Tom Lydon at ETF Trends posted an interesting question in “Muni Bond ETF Debate: Active or Passive?”
Should an exchange traded fund (ETF) be created to beat the benchmark index or outperform it? Municipal bond ETF providers are butting heads over the polemical issue of whether ETFs should offer an investor pure exposure or provide investment know how.
As it stands, the majority of providers such as BlackRock, State Street Global Advisors, Van Eck Global and Invesco Powershares believe passive is the way to go. Those landing on the active side of things include providers such as PIMCO, Grail Advisors and most recently Eaton Vance.
By the end of January, there were 27 muni ETFs available with $6.19 billion in assets. Prior to 2009, all muni ETFs were passively managed – the ETFs bought bonds in a target index and tried to provide a 95% correlation with the index.
Bond holdings in passive muni ETFs only represent a small portion of the overall bond index. Passive muni ETF portfolio managers aim to reflect the benchmark index through “representative sampling.” The portfolio managers would break down the index into categories like credit risk, duration and maturity, and weight the fund with bonds that recreates the aggregate risk characteristics of the benchmark.
PIMCO, like other actively managed ETF providers, believes that a portfolio manager should devote his or her time to research and beat the market. PIMCO launched its first actively managed ETF last year, the PIMCO Intermediate Municipal Bond Strategy Fund (MUNI). The fund has a published benchmark index but only uses it as a comparison. Grail Advisors shortly followed with its own intermediate fund, the Grail McDonnell Intermediate Municipal Bond ETF (GMMB). Most recently, Eaton Vance has registered to launch a series of actively managed funds.
Actively managed muni ETFs provide investment expertise of an established manager at a lower cost than mutual funds and greater transparency. For instance, Grail’s muni ETF has an expense ratio of 0.35% while the average mutual fund fee is 0.9%.
More important than the active vs. passive argument at this point is whether these issues are even worthy of investment consideration. The 2 funds mentioned above (MUNI and GMMB) are tiny in size ($20 million and $5 million) as well as extremely weak in volume.
I did not even bother to look at the bid/ask spread, because most of these new offerings need some time to establish themselves in the market place. My rule of thumb is that I want to see at least 9 months of price data to be able to look at their trends and make comparisons. That’s the time where you can revisit the idea as to whether active beats passive or not.
Right now, I simply acknowledge that these ETFs have come on the market, but would not consider them investment quality. It goes without saying that I have no holdings in any of the ETFs mentioned above.
Comments 2
Ulli: When you manage money for your clients, do you have a mix of investments in stocks and bonds? I realize that you move out of the funds when the trend tracking dictates so. But when in the market, do you have a mix of bonds and stocks or is it only stocks? Thanks for taking the time to respond.
Anon,
I use mutual funds, ETFs and bond funds depending on the client's needs.
Feel free to contact me directly for more info.
Ulli…