Will 2014 be finally the year for active ETFs? There are currently over 1600 exchange traded funds (ETFs) in the U.S. and approximately 4,000 worldwide. Most ETFs follow an index passively; for example, the SPDR tracks the S&P 500 index and the portfolio consists of the S&P 500 stocks, weighted according to the index.

Beginning 2008, active ETF were introduced where managers engage actively in portfolio holdings to outperform the benchmark index. The growth of active ETFs has been slow with approximately 71 at the end of 2013. PIMCO (Pacific Investment Management Company), the largest bond fund in the world, recently filed registration with the SEC for 19 actively traded ETFs. This will supplement their current seven active ETF funds for a grand total of 26 funds.  The filing is fueling speculation that actives ETFs may see a spurt in growth in 2014.

The performance of active ETFs has been mixed. The table below shows the average one-year returns of five funds with a minimum of three active ETFs as of February 7, 2014.








No. of Active ETFs






Max Return












Min. Return







The returns indicate a very volatile year for active ETFs in 2013, similar to the stock and bond markets where the S&P 500 generated a return of 32.4% while the bond markets yielded a negative 2.2% return (based on Barclays Aggregated U.S. Bond Index).

Active Bond ETFs fared the worst with PIMCO taking the biggest hit in the above table, followed by WisdomTree. Equity based ETFs performed the best with Columbia’s large growth (RWG) ETF registering 34.65% in returns. Similarly, AdvisorShares’ Midcap Blend (TTF) registered a high return of 29.46% although it should be noted that they also experienced a large loss with their Bear Market (HDGE) ETF at negative 22.89%.

Other categories of active ETFs also underperformed or showed lackluster performance.  As shown below, both bond and single currency funds declined in contrast to stock ETFS.  Others that did not perform well include specialized ETFS such as bear market, multicurrency and managed futures funds (not shown).


Single Currency

Emerging Market Bonds

World Bonds

Large Growth Stocks

Large Blend Stocks

No. of Funds






1-year Returns







Given the volatile performance above, why would investors opt for active rather than passive ETFs? The reason is the same as the demand for actively managed mutual funds. Despite evidence that less than 30% of actively managed mutual funds outperform the standard benchmarks, investors continue to invest in them.  It reflects the risk attitude of investors who are willing to take a chance of achieving a high return in spite of the low probability.

The popularity of active ETF funds may however depend on a new innovation – nontransparent active ETFs.  Currently, funds have to report the holdings of their individual assets daily. Managers are reluctant to reveal their holdings for two reasons; other investors can mimic their strategy without having to pay and front running, where investors can trade ahead of the ETF if a large block of shares are to be purchased or sold. If ETFs are allowed to withhold information on the holdings of their assets, more funds are likely to offer ETFs.  Ideally, managers would like to report their holdings quarterly, similar to mutual funds.

The SEC however is concerned that investors may not be able to price and trade ETFs if the composition of assets is not known. It also makes the process of arbitrage difficult since investors will be unable to detect any divergence in ETF prices and the price of individual assets in the ETF.

Two broad solutions have been offered by firms that have filed for nontransparent ETFs at the SEC. The first is to provide sufficient information on the portfolio holdings for investors to price and arbitrage but without revealing the complete holdings of the portfolio. The second is to create a blind trust between the authorized participants (APs) and the fund and to allow redemption by cash only. It is not clear whether the SEC will approve the applications. There are indications that they are seeking the best model for authorization of non-transparency ETFS. If they approve, we are likely to see a burst of new issues of nontransparent ETFs in a very short time. If they do not approve, growth of ETFs will continue but at a much slower pace.