New Managed ETFs Try to Beat the Market

The first actively managed exchange-traded funds might show up on your broker's screen later this month or early in April. PowerShares Capital Management expects to launch four funds that will be attractive -- it hopes -- to retail investors who want to try their hand at beating the market.

The start date can't be graven in stone. All depends on when the funds are cleared by the Securities and Exchange Commission, which has been pondering active ETFs for eight years. Nevertheless, their day seems close. Other fund companies with active ETFs in registration include Bear Stearns, Barclays Global Investors and Vanguard Group.

The next question is going to be: What are these new investments good for? Will you want them or are there better ways to go?

There's nothing exotic about ETFs. They are merely an alternative way of delivering mutual funds.

With traditional, open-end vehicles, you buy shares from the fund itself, which redeems them when you sell. You can buy in one of two ways: Either deal directly with a no-load (no sales charge) fund at a low cost, or buy through a broker or commission-based adviser at a higher cost. Due to those higher expenses, broker-sold funds, on average, show poorer returns.

ETFs, by contrast, are available only through brokers. They are baskets of individual shares, like any other fund. But they are structured as stocks that you buy and sell on an exchange. You pay regular brokerage commissions, which means you can trade through discounters. ETFs' annual expense ratios (what to pay to maintain the investment) aren't as high as those in traditional, open-end funds. For customers of brokers, this makes them a better buy.

So far, ETFs have all been tied to an index of some sort. The most popular ones track two major indexes -- SPDRs and PowerShares QQQ. Many track unusual indexes that were designed for ETFs. Examples would be indexes for dividend strategies or global mega-caps. These indexes screen securities for specific details, making them managed funds in disguise.

The PowerShares Four -- three equity funds and one bond fund -- will be managed openly. Two are quant funds: PowerShares Active AlphaQ Fund, owning 50 Nasdaq stocks, and PowerShares Active Alpha Multi-Cap Fund, owning 50 U.S. large caps. Quant funds are essentially run by computers that trade stocks based on mathematical formulas.

The third equity fund, PowerShares Active Mega-Cap Portfolio, run by managers at Invesco Institutional, will hold U.S. mega-caps. Invesco will also manage the bond fund, PowerShares Active Low Duration Portfolio. All four funds hope to beat the markets they represent.

PowerShares won't comment on how much these funds will cost. Presumably, they will be cheaper than traditional actively managed funds. If you work with a broker and believe that active managers can beat the market over time, active ETFs will be the better buy.

But can these managers really beat the market over time? Years of research says that, on average, they probably can't, especially not in the large, liquid markets chosen by the PowerShares Four. There are no niches for clever managers to exploit, and no little-known stocks that analysts aren't covering.

"The dynamics of beating the market are harder today than ever," says Ron DeLegge, editor of ETFguide.com. The managers will be hard-pressed to add enough value to cover their extra costs.