Jim Wiandt

World's First Active ETFs Begin Trading in Germany

In a development that would be unthinkable in the United States, the world's first actively-managed ETFs began trading in Germany just three months after DWS Investment filed for approval. Peering through a window that might shed some light on how such funds might work in the United States and elsewhere, IndexFunds.com spoke at length with Helge Staack, product manager for the new trading funds.

"The first day of trading went very well, and though it was a difficult day for the market makers, the funds traded with a difference between the buy and sell (bid/ask prices) of 1 percent for the technology and biotech funds, for example. The amount traded on the Frankfurt stock exchange was two and a half million Euros," said Staack.

How The New Funds Performed In Early TradingData Courtesy of Deutsche Brse includes first two days of trading through 11/21/2000

Exchange-traded funds (ETFs) are mutual funds that trade like a stock. Each fund holds a group of component stocks, with trading of the exchange-traded shares closely approximating the underlying net asset value of those stocks. Until now, every available ETF has tracked an index with known component stocks. The offering by DWS has changed all that.

Die Wertpapier Spezialisten (DWS) is an arm of Deutsche Bank Gruppe. The new DWS funds launched by DWS Investment trade on the Frankfurt Exchange's Xetra platform and consist of broad German, European, Asian, U.S., and global funds, as well as Biotech, Internet, Pharmaceutical, U.S. Technology, Emerging Markets, and Gold funds.

Previous to the DWS launch, the European Exchange-Traded Fund Company launched two listed diversified return securities (LDRS) on the German Deutsche Börse. These funds are co-managed by Merrill Lynch and track the Dow Jones Euro Stoxx 50 and Stoxx 50 indexes. They began trading in April, 2000.

Thus far, logistical and regulatory hurdles have stymied all efforts to launch active ETFs. While AMEX hopes to launch active ETFs in the United States sometime in 2001, it is still unclear how near U.S. fund managers are to clearing Securities and Exchange Commission (SEC) and Internal Revenue Service (IRS) regulatory hurdles.

Of particular concern has been the issue of how disclosure of the underlying stocks would work. While active managers do not want the market to know which stocks they are buying and selling, it is important for investors to be aware of what the net asset value (NAV) of the underlying basket of stocks is, so that they can trade the ETF shares based on that value.

How the active funds trade in Germany

Because German fund managers are not subject to stringent levels of disclosure that American fund managers are, it was considerably easier to gain approval for the funds than it would be in the United States. In fact, according to Staack, working out a contract with the Frankfurt Exchange (where ample information on the new funds in English and German can be found) was a far greater obstacle to DWS than obtaining regulatory approval.

Essentially, here is how the new funds trade: While component stocks are not disclosed, once a day at the market close, DWS releases a net asset value (NAV) price for the underlying stocks comprising the funds. Based on this information and the direction of the relevant market/sector, the funds trade freely during the day.

And here's another interesting twist with the DWS funds. According to Staack, "Investors have two ways to invest. An investor can buy the fund for the net asset value, at this price, but only once a day. You can also buy them at the trading value while the market is open."

There is at this time no real-time disclosure of the fund's NAV, although market makers are privy to additional information about the component stocks that helps them to better price the funds (something that, incidentally, would be unthinkable in the United States).

Says Staack, "We give some more information to the market maker to give him an idea of the underlying portfolio. As investor you have a chance to invest at what is not the real net asset value. But that is what makes it interesting." Indeed.

In addition, once a month, DWS provides extensive fact sheets that reveal the funds' top ten holdings and fundamentals data.

Below is a list of every ETF currently available in Germany, along with the relevant fund manager and the benchmark index that the fund can fairly be compared with (or actually tracks in the case of the index funds). The first 11 funds are the new active ETFs launched November 20, 2000 by DWS Investment.

Chart Courtesy of Deutsche Brse is current as of 11/21/2000

Despite the different regulations faced by U.S. and German fund managers, the new ETFs do provide an interesting vantagepoint from which to see how U.S. active ETFs may ultimately be structured. Obviously the manager of a large active fund doesn't want the entire market to know what he is buying and selling. It is difficult enough to trade in large quantities without being front-run by the market. Index fund managers know this well.

The remaining question is to what extent active ETF managers will be able to conceal their holdings. The launch in Germany shows that not only is it possible to provide an NAV without revealing holdings, but that the funds can trade intraday with no real-time gauge of what the NAV even is. It will certainly be interesting to see how such funds are ultimately structured in the United States, but the odds are that the launch in Germany will provide additional impetus for the introduction of active ETFs in the U.S.