Exchange Fund Called Actively Managed
November 27, 2000
The financial world may have to wait a little for the first actively-managed, exchange-traded fund, at least for the kind that leading exchange-traded fund sponsors are trying to develop.
On Nov. 20, the Frankfurt stock exchange began listing eleven equity funds of DWS Investment, a unit of Deutsche Bank, both of Frankfurt, Germany and the company announced it had come out with the first actively-managed exchange-traded fund in Germany.
The announcement has commanded considerable attention. After all, exchange-traded fund sponsors have been talking about developing actively-managed exchange-traded funds and many industry consultants maintain that the products will soon be available. But, there remain obstacles for these companies, including getting the approval of the SEC. The launch of the first exchange-traded fund in Germany is therefore noteworthy.
However, it is becoming apparent that the actively-managed exchange-traded fund that DWS has introduced is not really the kind of product that other companies are struggling to develop.
Existing exchange-traded funds are similar to index funds in that they invest in the companies of, and therefore mirror, particular indices. If someone buys shares in an index fund, the mutual fund company purchases the stocks. For exchange-traded funds, however, companies buy the stock and keep the certificates in a bank. The shares are bought and sold among investors, rather than between the mutual fund company and investors.
Creating an actively-managed exchange-traded fund is problematic because a transfer agent or custodian handles the shares. As a result, at the point that the shares are presented to a custodian, the portfolio of the fund is disclosed. With exchange-traded funds mirroring indices, the portfolio is already known. However, continuous disclosure of an actively-managed fund would introduce the problem of front-running.
The portfolios of the eleven actively-managed DWS funds on the Frankfurt stock exchange are released to the public once a month, according to Thomas Richter, a spokesperson for DWS.
The difference between a traditional exchange-traded fund and the DWS products is the pricing mechanism. The market determines the price of an exchange-traded fund, and since the portfolio is known, it generally trades close to net asset value. If a gap between the two arises, investors can take advantage and 'arbitrage' the shares, and the gap will close in a fairly short time.
With the DWS funds, a Deutsche Bank market maker' will price the funds throughout the day. Investors can buy or sell shares from each other or from the market maker when there is a bid offer gap, according to Richter. The market maker is legally responsible for keeping that gap as small as possible with a maximum of 2.5 points, and one day after trading, the market maker buys or sells shares of the fund, according to Richter. The fund then receives inflows or outflows only once per day. DWS, in an effort to create an alternative way of buying the fund, simply has listed the fund on the exchange, with Deutsche Bank setting the market.
"Basically, this is a sales channel," said Richter. "It's just another way of ordering."
Having the portfolio known to investors is one of the advantages of exchange-traded funds. Now, if investors think an index will go up or down, they can trade the respective exchange-traded fund during the day, in response. This intra-day trading adds flexibility to exchange-traded funds, which is one of the advantages over ordinary index funds. If the portfolio of an actively-managed fund is released only once a month, the value of that flexibility is diminished. Yet it remains a selling point of the funds for DWS.
"Up to now, our [funds] impressed mainly by their performance," said Udo Behrenwaldt, chairman of DWS' board of directors. "Now, apart from having no front-load, they offer investors additional value in terms of increased flexibility and speed. The listing means even better customer relations with increased service and transparency."
The portfolio is not very transparent though, if investors are only made aware of the holdings once a month.
Barclays Global Investors of London is currently working on developing an actively managed exchange-traded fund, but one quite different from those DWS has introduced.
"When we and pretty much everyone in the industry talk about actively-managed exchange-traded funds, we're talking about funds that release their basket of securities every day," said Christine Hudacko, a spokesperson for Barclays. "That's what is so difficult about coming out with them. For exchange-traded funds, the knowledge of these baskets of securities is essential. As far as BGI is concerned, that is what actively-managed exchange-traded funds must do."
DWS products, technically, are actively managed exchange-traded funds. Still, the initial excitement surrounding them as a possible model for other products seems to have subsided as details about their design have been disclosed.