How does Fidelity [profile] launch an active ETF?

Very slowly.

Ron O'hanley, Fido's president for asset management explained his interest, and concerns about the burgeoning product category before a gaggle of reporters at the Morningstar Investment Conference in Chicago Friday.

He started his comments on the subject in this way:

We think, I would say in general, that we've seen the end of Chapter 1 in ETFs. There is a lot more left to come in ETFs, and we think active will be a very big part of that. We think, for a lot of reasons, and it is not just the intraday trading of it. There are certain things that shouldn't be done on an intraday basis.

He said, "we think there is a lot of opportunity to put active strategies, starting with fixed income, in an active form."

However, he added, "these products and strategies and structures have not been tested under stress yet. This is a little bit of stress test that we want to do."

He brought up the subject of fixed income and the challenges it could provide.

Fixed income, for example. Until very recently, we have had several years of a very benign fixed income market.

All the broker dealers that make markets have turned into brokers. If you look at dealer inventories that until 2008 were carrying $250 billion of bonds at any given time, that is now around $40 billion in dealer inventory.

All I am saying is that these things haven't been tested yet. We filed so you know we are interested. We want to understand what happens in times of stress.

He noted an important difference between the stock and bond markets during the discussion. The stock markets are a highly liquid exchange driven market.

"If you want to sell something, the exchange will find a buyer, maybe not at the price you want, but it will find a buyer," he said.

But with bonds, there were some days during the crisis that liquidity essentially dried up.

Part of the problem, is the complexity of these securities. A company may have a handful of share classes for its stocks, but could have several dozens of bonds associated with its debt.

"In a central exchange [for equities], you basically are buying and selling something that is homogenous," but, he said, "the bonds two people may own may be completely different."

This, he said, is the reason why he worries over the Volcker rule, which can cause problems for banks and other institutions seeking to serve as market makers. Depending on how the rule is interpreted, banks holding securities for the sake of making a market could get into trouble for prop trading.

"How do you draw the line between something that is proprietary versus something that is being done to facilitate a market?" he said. 

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