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Monday, January 27, 2014

If I Were the CEO of an Active Manager, I'd Be Nervous

Reported by Tommy Fernandez

Dave Nadig, CIO of the newly-rebranded ETF.com, isn't quiet about his qualms about the actively managed mutual fund biz.

"If I were the CEO of an actively managed fund firm, I'd be nervous," he told MFWire at the ETF.com conference hosted here at the Westin Diplomat in Hollywood, Florida.

He expects that in ten years, total ETF and mutual fund assets will be roughly on par, partly because '40 Act products are facing some challenges that he believes they cannot win.

Active funds, he says, are facing a losing battle when it comes to cost and taxes, as well as access and distribution. Not to mention the ongoing troubles related to performance. But even for the firms doing well in performance, Nadig says, "I'd still be nervous."

The tide is simply turning against such fund firms, he says.

Consequently, Nadig's firm, formerly known as IndexUniverse, has invested a great deal of resources in technology and talent with the hopes of positioning itself is the go-to resource for this industry.

"The decision we made, and the Street will ultimately tell us if we are right or wrong, is to essentially move for a 'Silicon Valley'-style land grab. It is literally early enough in this ETF revolution that we can, with the best possible tools, claim real estate in investors' minds. If you are buying an ETF, we have literally removed ever possible barrier to use us [i.e. ETF.com is free]. In the long run, if we become the center of the ETF universe, we'll find ways to capitalize on that," he said.

That's not to say there aren't challenges. For example, Nadig says that one of the best things about ETFs is that they give investors access to virtually every investable asset out there. The problem, he laments, is that very same thing.

Product proliferation, as well as what he calls the Gold Rush syndrome and toxic products, will always run the risk of burning less-than-careful investors, and that's something the ETF industry has to learn to deal with.

"On the one hand, we can get essentially zero tax impact exposure to every asset class in the world in a portfolio for something like 10 basis points. That is fantastic, that is revolutionary. On the other hand, someone like my mother could put her lifesavings in VIX futures," he said.

Nonetheless, Nadig expects fund firms to continue to experience flow movement from active products to indexes and ETFs. Some firms, like Pimco and Fidelity, are already responding by launching their own ETFs. He expects this trend to steadily build up steam.

Moreover, Nadig expects that by the second half of this year, the SEC will likely give approval to at least one of the numerous active management ETF models fund firms are proposing that will allow them to shield their investment strategies from daily disclosure. He doesn't know which model will get first approval, but he expects that likely all the proposals out there will get approval in one version or another eventually. Whether any of these succeed will be a matter of the right marketing and conversations with the market. He likens the process to the VHS versus Betamax battles of yore.

However, there are right ways and wrong ways for an active firm to tip toe into ETFs.

"If you have a vibrant active management business, don't expect to be able to just flip a switch into ETFs. Nobody has been able to do that. However, if you do it right, the impact on your firm and its culture can be minimal. If you do it wrong, it can be disruptive of your business," he said.

For example, with ETFs, there are no transfer agents, and you don't have to send out prospectuses, your strategies towards taxes would be completely different.

Also, your selling strategies would have to change. Many active funds are sold, not bought. The reverse applies to ETFs. Also relationships will change. Fund firm relationships tend to calcify, Nadig said, with firms doing the same business with the same custodians, board members, managers, what-have-you. The longer these relationships exist and the older the firm, the less likely these relationships are going to change.

However, it may not be in the best interest for a fund firm going into ETFs to use the same established relationships. For example, the super-fast creations and redemptions for ETFs isn't a skill-set possessed by all custodians, he said. Brown Brothers Harriman, he said, is great at this. Others, not so much.

To be sure, these changes are not made quickly, either within a firm or in the larger market. But firms need to deal with them, he says. The next ten years will seeing an irreversible turning of the tide.

In the meantime, ETF.com will continue to build itself a central place in this new universe, Nadig said.

"We're making an eyeball play here. We have the hubris to think we can fly the X-wing fighters of the Rebel Alliance in this. Call me in six months and I'll tell you how we're doing traffic-wise," he said.  

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