Is 'active ETF' an oxymoron?

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Grail Advisors has announced the registration of four "actively managed" Exchange Traded Funds. According to William M. Thomas, the CEO of Grail, "one of our goals from the outset was to bring traditional active fund managers to the ETF marketplace."

Here's my question to Mr. Thomas. Why would anyone want to do this?

According to Allan S. Roth's excellent book, How a Second Grader Beats Wall Street, the probability of a portfolio of ten actively managed domestic funds beating a total U.S. index fund over a ten year period is a pathetic six percent.

This is the "expertise" that Grail Advisors is bringing to the ETF marketplace.
Frankly, I have never understood the allure of ETFs. Most of them are not less expensive than comparable low cost index funds. The commissions you incur (since you will need a brokerage account to trade them) will reduce your returns, especially if you purchase them regularly. The "bid-ask" spread adds another element of cost. You can't reinvest the dividends back in the funds, like you can with index funds. Finally, the explosion of niche ETFs (like those that invest in cancer research stocks or in maritime shippers) encourages trading. Trading runs up costs. Costs enrich brokers and deplete your returns.

At least with traditional ETFs you can get some comfort from the fact that they will track their designated index. You have no such assurance with actively managed ETFs.

If the past performance of active managers is any indication, investors in actively managed ETFs will be disappointed.

Dan Solin is the author ofThe Smartest Investment Book You'll Ever ReadandThe Smartest 401(k) Book You'll Ever Read. His new book,The Smartest Retirement Book You'll Ever Read, will be published in the fall 2009. Visit his website: www.smartestinvestmentbook.com.
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