Active ETFs: A Conversation with Ken McCord

In March 2010, ActiveETFs | InFocus spoke with – Ken McCord, President of Horizons AlphaPro. AlphaPro is the sister company of Horizons BetaPro and is the only company in Canada to provide actively-managed ETFs to investors. Ken talks to us about AlphaPro’s plans, how AlphaPro will handle competition and where the opportunities and challenges lie for Active ETFs.

Shishir Nigam – Active ETFs | InFocus: Ken, welcome to ActiveETFs | InFocus and tell us a little bit more about yourself and how you got into the Active ETF space.

Ken McCord, President – Horizons AlphaPro: Well, I’ve been in the asset management industry for 18 years now and in the last 18 years I’ve seen some interesting change in our industry. I haven’t seen any ground breaking change or game-changing inputs into the industry until Active ETFs came along. I truly believe Active ETFs are a game-changer. I think they’ll change the way investors invest and I think they’ll change the way advisors advise. So, it became apparent to me that because that was going to be the next big revolution in our industry, I really needed to get on board early. And the opportunity came in September 2009, just 6 months ago, and we’ve seen a lot of changes since been on board.

Shishir: Where do you see the Active ETF space going in the next 5 years?

Ken: I think the Active ETFs will go exactly the same way that the passive ETFs have gone. For investors who choose to invest passively, they’ve always had a couple of choices – they could either do a passive mutual fund or a passive ETF. Overwhelmingly, they’ve chosen the ETF route if they’re a passive investors because it’s simply a better delivery mechanism. It’s cheaper, more convenient, more flexible. And I believe the same decision will be made by those who choose active management over passive. If you want active management, up till now, you’ve only been able to go mutual fund. Now, we can offer active strategies in an ETF and because I believe an ETF is a better delivery mechanism, I think investors will overwhelmingly choose it for its active management exposure. So I think the growth will be phenomenal.

Shishir: Have you been satisfied so far with the level of growth and investor interest you’ve seen in the AlphaPro ETFs within the Canadian space?

Ken: Well I don’t think an entrepreneurial spirit is ever satisfied with its growth. With the level of interest – absolutely, I know we’re starting something very new, very different and I think the growth is going to take a while to establish. But the level of interest has certainly been overwhelming and overwhelmingly positive. The advisors and the investors who understand what we’re doing truly believe that it is a better way to invest, it’s simply a better package to wrap around an active manager.

Shishir: Why do you think ETFs are a better structure for investors as compared to mutual funds?

Ken: I always use a metaphor when I answer this question. The last time I was in a record store, I picked up a Led Zeppelin album and it was $17.99 and I thought, “I don’t want to spend this much money on this album, and I’ve got limited use to it – I can only play it in my car or my radio at home.” So I went home and I downloaded the same content on iTunes for $9.99 and now I’ve got it on my computer, I’ve got it on my iPod, I can listen to it on the treadmill or on the airplane, whatever. And so I compare iTunes and the compact disk, similar to an ETF and a mutual fund. You’re getting the same kind of content – really what I want when I went to the record store was Led Zeppelin and Robert Plant and Jimmy Page. And once you make a decision on the content, you should really then try to find the most convenient, flexible and economical delivery mechanism or package, and the compact disk isn’t it – it’s iTunes. And I’m now trying to say to the world, the mutual fund isn’t it. If you’ve chosen to go with active content and find your own portfolio management “rock stars”, then the ETF is a better mechanism and a better delivery vehicle because it is less expensive, it’s more convenient and more flexible.

Shishir: How long do you think you can maintain your monopoly on the Canadian Active ETF space? Who do you think is going to be your likely competitor?

Ken: I don’t think it will last long and I welcome more competitors because it will simply legitimize what we are doing. I think some of the Canadian competitors on the passive side have chosen not to adopt or embrace Active ETFs. I don’t know why, I think they’re really missing out on something. So I believe our competition will come from the US. We’ve already seen some big name managers embrace Active ETFs – we’ve seen PIMCO, Putnam, T. Rowe Price, Legg Mason. They’ve all announced their intention or if not already started actively-managed ETFs. So I think it is only a matter of time before one of the big US players comes up here. So in the mean time, we really need to build a foothold, we need to be the brand of choice, we need to build out a full line of products and we need to establish track records that are the longest in the industry. And that’s exactly why we’re so busy right now, bringing products to market.

Shishir: Majority of AlphaPro’s Active ETFs have a hedge fund-style performance fee attached to them. How is AlphaPro looking to compete with mutual funds when most such ETFs only charge a management fee?

Ken: Most ETFs just have a management fee because they are passive in nature so you would never put a performance fee on a passive ETF. In terms of the mutual fund space, you can put a performance fee on a mutual fund and there seems to be a movement towards performance fee in mutual funds with a lower management fee. We have received overwhelming validation of our thesis that investors would much rather pay a lower management fee and pay up for performance if they get it. If they don’t get it, don’t pay for it. And we truly believe we should be paid for our success and not be paid if there isn’t any success. So we’ve chosen to keep much lower management fees and add a performance fee only where we actually deliver performance or alpha against the benchmark.

Shishir: 85-90% of mutual funds are currently actively-managed. How do you see Active ETFs penetrating into RRSPs and 401(k) retirement portfolios which are currently dominated by these mutual funds?

Ken: Again, what we’re trying to do here is ground breaking change and I think anytime you try to introduce dramatic change in anything, whether it’s social or political or financial, it takes time. And it really needs to start at the grassroots often. So one thing we have to do is to get the investor on the street aware of what we’re doing, that they can get access to great managers for low fees and get them to start asking for that directly from the investment dealer or to get them to ask for it through their investment advisors. That’s going to help deliver demand and growth in the Active ETF space. The other thing is just to educate our advisor base. We have a great network of investment advisors across Canada. They know us very well from the BetaPro business – and to introduce this concept to them as the next logical conclusion. So we can educate them and teach them how to use Active ETFs in their book of business, where they might otherwise use a mutual fund.

Shishir: Finally, what are the strategies that AlphaPro is looking to bring to investors in the future through Active ETFs?

Ken: My goal really is to build a family of ETFs that will rival that of any mutual fund company seen in Canada today. That means all the traditional mandates – from equity to fixed-income to balanced, domestic, global and anything you can think of. The other thing I want to do for investors is bring some strategies that are less correlated to the equity market than we might be used to. And I still think Canadians probably have a little too much exposure to equities in their investment portfolios and we need to bring some strategies to the market that are less correlated with the equity markets.

Shishir: Ken, thanks a lot for joining us and we wish you all the best for the future.

Ken: Thank you Shishir, my pleasure.