The wider investment community is increasingly acknowledging the attractions of ongoing innovation in this space. While the US has led the way, assets in active ETFs in Europe have risen considerably.
Research from HANetf shows actively managed ETFs accounted for a record 25 per cent of global ETF flows in the first half of this year.
In Europe, active ETFs notched $5.9bn of inflows across the same period and now represent more than $45bn in assets under management.
Although this figure still represents only a small percentage of ETF assets under management worldwide, the direction of travel is becoming clear. The number of active ETF issuers is growing.
In tandem, issuers are expanding and diversifying their offerings. There are some hybrid active ETFs such as the JPMorgan “enhanced ETF” range, which offers, for example, access to indices but with exclusions.
Typically, active ETFs have focused on specialist niches such as healthcare and single countries. But we are now beginning to see managers offering mainstream, one-stop-shop retail investment vehicles within the active ETF structure.
Comparisons
I have managed a unit trust, an investment trust and now an active ETF. So what do I see as the main benefits of each, beyond them all offering professional active management?
Unit trusts:
- can usually be traded daily at NAV if underlying assets are liquid. Less suited to illiquid assets such as property;
- have a wide array of options.
Investment trusts:
- can be traded when markets are open but may sell at a discount or premium to the NAV and will have a bid-offer spread, which may be higher for less traded trusts;
- closed-ended basis can make them an effective structure in which to hold illiquid assets;
- management fees tend to be cheaper than for unit trusts;
- perhaps because they have a board to represent the interests of investors;
- can gear to enhance returns in positive markets.
Active ETFs:
- can be traded when markets are open at NAV — though there may be a bid-offer spread. For liquid assets the bid-offer spread should be small;
- are highly transparent — they disclose the entirety of their holdings daily. This can be particularly useful for advisers wishing to blend active ETFs within a broader portfolio who need full disclosure of underlying holdings to optimise non-correlation and diversification;
- costs are readily apparent;
- the share creation and redemption process can be more cost effective for providers and tax efficient. These cost benefits are potentially augmented by tax benefits for European investors, particularly when investing in Irish-domiciled ETFs, which tend to have lower withholding tax on dividends from global equities — especially US equities;
- this means they tend to be cheaper than mutual funds but more expensive than passive ETFs, so the managers still have to demonstrate they are delivering value for money;
- though they have been largely limited to specialist vehicles to date, more mainstream funds are now coming on stream.
An additional benefit of investment trusts and active ETFs is that many retail platforms charge for holding a unit trust in a pension or Isa — as much as 40 basis points a year – but some will cap the cost of holding company shares.
So, for wealthy investors, platform costs can sometimes be significantly reduced by opting for investment trusts and active ETFs.
Role of ‘authorised participants’
One question I am often asked is how an active ETF manages to dodge the issue of discounts and premiums that can beset investment trusts.
This is thanks to the role of “authorised participants”. If you want to trade your shares in an ETF, market makers will help to match you with a buyer, and vice versa. However, if there is no buyer or seller then the APs step in to redeem or create shares. These tend to be large banks such as JPMorgan Chase, Morgan Stanley or Goldman Sachs.
They make their profits on arbitrage — on the bid-offer spread. There are no authorised participants for investment trusts. These rely on the boards to issue or buy back shares. Without this arbitrage mechanism, active ETFs would trade like investment trusts.
