Now that exchange-traded funds are a better fit for active managers, Mario Gabelli is signing on. The seasoned investor — who eschews index funds — says he can’t afford to miss out on ETFs any more than he can ignore social media.
Gabelli, 72, remains a staunch advocate of actively managed funds. He’s a regular and outspoken commentator on raucous stock-picking shows like CNBC’s Halftime Report, on which he recently said he “took a dumb pill” by not buying Netflix stock at a fraction of its current price. (Shares in the Los Gatos, California–based online movie and TV streaming provider closed at $474.91 on February 27, up 39 percent since January 12.)
Although investors’ love affair with ETFs has so far been part of a bigger move to indexing strategies, active managers are thinking about how to leverage these products’ tax, cost and other advantages. Last year U.S. investors sent more money to passive funds than active ones for all equity categories, according to Chicago-based research firm Morningstar. In fact, active U.S. equity experienced outflows for ten months in 2014, even as its passive counterpart saw inflows for 11 months.
Gabelli, the founder, chairman and CEO of $47.5 billion, publicly traded GAMCO Investors, isn’t reinventing the ETF wheel to get into the business. His Rye, New York–based firm is licensing NextShares’ ETFs. Offered by Navigate Fund Solutions, a subsidiary of Boston-based Eaton Vance Management, the NextShares funds protect the confidentiality of portfolio information.
Traditional ETF portfolios are completely transparent to the market, not a concern for index trackers. But active managers don’t want to broadcast their unique securities picks on a daily basis, giving others a chance to profit from the information. For example, if traders know that GAMCO is building a position in a certain stock — say, Twentieth Century Fox Film Corp. — they can buy shares and drive up the price. “We do small-cap, nanocap, microcap investing,” Gabelli says. “We don’t want our portfolio exposed daily. It defeats what we do — to provide incremental valued-added.”
One of the criticisms of active funds is that their high fees can cut into investors’ returns. Stephen Clarke, president of Navigate, says NextShares eliminates almost all transfer agency costs, can reduce trading costs and offers tax advantages. “This has the potential to provide widespread benefit for fund investors in active strategies,” Clarke contends.
Part of Gabelli’s motivation for licensing NextShares is to make his active funds as low cost as possible. The tax efficiency of exchange-traded products is particularly appealing because traditional fund investors get treated unfairly, he says. When real estate investors sell a property and roll the proceeds into a new investment, they don’t pay tax. Fund investors pay tax on capital gains distributions even if they reinvest the money in the fund. But through so-called in-kind redemptions, ETFs can remove stocks that have significantly increased in value and could trigger large capital gains taxes.
Gabelli doesn’t hold back on his criticism of index funds, which he says hurt the capitalist system by being “mindless,” allocating money to companies according to a computer program, rather than fundamental research. He thinks passive investors weaken governance because index funds don’t vote proxies often enough or pressure management to improve. Passive funds “are destroying the notion of investing,” Gabelli says.
As an active investor, though, he believes the decline of investment research in the U.S., and in Europe soon, makes his job easier. This decline began in the mid-1990s after regulatory and other changes undermined the economic incentives to create in-depth research. In 2003 U.S. attorney general Eliot Spitzer prohibited firms from using investment banking revenue to underwrite such efforts. European regulators are considering similar changes to the way asset managers pay for research.
“We have research,” Gabelli says. “While the rest of the world is going the other way, we’ll get an advantage. Now we have an outlet for that in a nontransparent ETF.”