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‘Active’ ETFs: fund managers jump on new bandwagon

‘Active’ exchange traded funds are not the contradiction they appear, but are they a good idea and how transparent should they be?

 
‘Active’ ETFs: fund managers jump on new bandwagon
 

Just as investors got accustomed to an army of exchange traded funds (ETFs) passively tracking every conceivable stock market index, now some fund managers are wrapping their actively managed funds within an ETF structure.

With several ‘active’ ETF launches in Europe this year, the market appears to be nearing a tipping point – but more regulatory clarity is needed on portfolio disclosure and how transparent these funds need to be.

What are ‘active’ ETFs?

Active ETFs are listed and can trade throughout the day like any other ETF. But instead of being index-based or following ‘smart beta’ rules, they can be as actively managed as a conventional unit trust or open-ended investment company (Oeic).  

In Europe there are 19 active ETFs or exchange traded products (ETPs) with assets of $8.3 billion as of the end of September, compared with $5.8 billion at the same point last year, according to consultancy and research firm ETFGI.

‘Providers are trying out different strategies within the ETF wrapper to see what investors embrace,’ said Deborah Fuhr, managing partner and co-founder of ETFGI.

‘Asset managers in general have seen very impressive flows into ETFs this year, way above any prior year, and see ETFs as a new distribution channel,’ she said.

Thundering herd

Michael John Lytle, an ETF consultant and former chief development officer at Source, added that the herd mentality will drive more people towards active ETFs.

‘The tipping point is there purely due to the number of assets already in the ETF space, as well as the number of asset managers who have never been in the ETF market and want to see what wrapping existing products in ETFs does to their assets,’ he said.

Recent active ETF launches in Europe include funds from First Trust and JP Morgan Asset Management.

The First Trust FactorFX Ucits ETF is the first actively-managed foreign exchange ETF in Europe with 0.75% fees. It holds a basket of currency pairs, selling lower yielding currencies and investing in higher yielding ones to earn a positive interest rate differential.

Derek Fulton, chief executive at First Trust Global Portfolios, said the fund strategy was designed to produce a positive yield ‘regardless of the direction of interest rates without adding to existing credit or liquidity risks.’

JP Morgan Asset Management (JPMAM) is launching two ETFs. The JPM Equity Long-Short Ucits ETF  looks at value, quality and momentum in developed global equities, while the JPM Managed Futures Ucits ETF exposes investors to a range of asset classes.

Bryon Lake, head of international ETFs at JPMAM, said investors wanted funds that had a lower correlation to the overall market and could diversify their portfolios.

To see through or not?

However, a recent paper on ETFs from the Central Bank of Ireland raised important questions about the limited transparency of active ETFs, compared which market-size weighted ETFs which reveal all their holdings every day.

The lack of clarity is arguably slowing active ETF development. For example, Fidelity launched its first smart beta ETFs in April but has not yet launched active ETFs.

Nick King, head of ETFs at Fidelity International, said the company is ‘certainly looking at ways that we can provide our active capabilities in an ETF wrapper’, but portfolio disclosure was the key challenge.

‘There is a lot of regulatory focus on this. I believe that there is a significant opportunity once there are commonly accepted standards for disclosure and everyone becomes comfortable with these,’ he said.

But Lytle said he believed the concerns around transparency were overblown as active funds traditionally did not reveal all their holdings.

‘I go back and forth on this,’ he said. ‘Investors have been used to traditional active funds only revealing their top holdings or sectors once a month for decades. Is this level of transparency needed [for active ETFs]?’

Fuhr insisted that the future looked bright for ETFs in general, and active ETFs would be helped as a result.

‘We’ve clearly seen a growing array of investors using ETFs and we know certain evolutions will increase their use, like Mifid II [a new European regulation] in January and platforms using more ETFs.’

3 comments so far. Why not have your say?

Franco

Oct 25, 2017 at 12:15

Actively managed ETFs are an obvious development. There are still many people in this World taken in by the hype and the advertising industry is ready to do its bit..

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Law Man

Oct 25, 2017 at 18:15

I can understand use of, say, Momentum as a passive mechanical selection criterion. However, a basis of long (high interest)/ short (low interest) currencies seems to involve risk (the high interest currency falls in value compared with the low) or subjective choice.

Overall, I prefer the concept of ETFs to track a standard index at very low cost; while paying a manager to make choices.

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richard tomkin

Oct 26, 2017 at 09:21

I believe greatly in the maxim Keep it Simple.We have seen in the past the damage done by "too clever by half" structures and practitioners.As a rule of thumb,the more opaque a proposition,the greater the risk.In the context of ETFs,I would not be surprised if the synthetic or swap-based index replication model is not the next accident waiting to happen,to rival perhaps the split capital scandal in the IT world a few years back.

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