US takes active ETFs to next level while Europe stays cautious
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Actively managed exchange traded funds are proving so successful in building scale that they are set to win a greater share of investors’ cash — at the expense of both conventional mutual funds and passive ETFs, according to industry figures.
The investment vehicles — which, unlike mutual funds, are listed on exchanges — still constitute only 4 per cent of the overall ETF market, according to TrackInsight, a data provider. However, its latest figures show this share is increasing rapidly: active ETFs’ assets under management grew 13.7 per cent in the first quarter to reach $318bn. That compares with a 7.3 per cent growth, to $8.1tn under management, for the broader ETF market.
Industry observers attribute the increase in demand to two factors: new active thematic ETFs, such as the suite of products from Ark Invest; and the US Securities and Exchange Commission’s approval in 2019 of so-called semi-transparent ETFs.
This regulatory change approved several different product structures for active semi-transparent (or non-transparent) ETFs, most of which avoid the need to disclose the funds’ direct holdings and instead allow managers to publish a daily proxy portfolio with a similar risk profile. As a result, market participants can still get a sense of what is inside the fund but without other managers being able to replicate it exactly.
Proponents argue that this guarded approach prevents other market participants from “front-running” the products — trading assets based on insider knowledge of who else will be buying them.
US investors using these ETFs can also benefit from lower fees and taxes compared with mutual funds.
“Semi-transparent ETFs allowed investors to access strategies that previously might only be available under mutual funds or separately managed accounts,” says Giang Bui, head of US exchange traded products for Nasdaq.
Yet active transparent and semi-transparent ETFs face challenges and limitations, analysts warn.
Active strategies, unlike index tracker funds, cannot rely on the record of an index to show performance. Instead, the managers have to prove themselves independently — a process that takes several years.
“Whenever you launch an active ETF, you know that it is not going to be a blockbuster right out of the gate,” says Anna Paglia, Invesco’s global head of ETFs.
Recent efforts by two US asset managers — DFA and Guinness Atkinson — to repurpose mutual funds as ETFs could be seen as a way of overcoming this issue, says Ciarán Fitzpatrick, head of ETF servicing, Europe at State Street. He adds: “That is an avenue where asset managers are looking at potentially being able to carry their record forward.”
Paglia says there will probably be a mutual funds-to-ETFs migration by investors, “where active ETFs are going to play a critical role”, she says. “This market is evolving.”
Some believe there is more room for innovation in active ETFs as investors and regulators become more familiar with new products.
Bui argues that expanding the semi-transparent universe to asset classes such as fixed income is the next frontier for the industry.
At present, the SEC allows only US equities to be included in semi-transparent ETFs but a global survey published by Brown Brothers Harriman in March, which captured responses from 382 ETF investors, identified fixed income as the asset class that people would most like to see added to actively managed ETFs.
Meanwhile, in Europe, where regulators are proving more cautious, none of the semi-transparent formats have been approved for use and there is still no clear indication as to when this might change.
Market fragmentation in the bloc poses particular challenges and some believe regulators, such as the International Organization of Securities Commissions (Iosco) and the European Securities and Markets Authority (Esma), need to adopt a unified approach.
“You need Esma and Iosco to give a blanket approval so that the individual regulators can follow suit,” says Fitzpatrick. “I don’t think one regulator approving semi-transparency in one market is going to solve anything.”
However, others believe it is just a matter of time before the new vehicles take off in Europe.
“It’s likely a question of when, not if, active management plays a more meaningful role in Europe,” says Todd Rosenbluth, head of ETF and mutual fund research at CFRA Research. “I think [it will] pick up over the next three to five years.”