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Fund Buyer - Active ETFs: the next big thing?

Date: 22 February 2024

4 minute read

On today’s fund buyer I discuss a major trend in the US asset management industry that has gone somewhat unnoticed in Europe, the rise of active ETFs. We are beginning to see these instruments move into Europe, but they are nowhere near as popular as in America. Could the next couple of years see that change?

Before we delve into the details, what exactly do we mean by an active ETF? For many, ETFs are synonymous with passive investing, but an ETF is simply a vehicle that holds an underlying bundle of investments. Essentially, it is nothing more than a wrapper. It also has the benefit of trading throughout the day on the back of live prices, and as such, can allow traders greater opportunity to time the market, should that be what they are aiming to achieve.

In the US, the active ETF market is growing rapidly, up around 30% last year, and accounts for around US$500bn in assets. Bear in mind that this is new growth in active management, bucking the trend and general narrative that active management is simply seeing outflows. So why are they proving so popular? In the US the major factor is taxes. These vehicles are much more tax efficient than open ended vehicles, and that has been the clear driver.

There are other factors to consider though. ETFs trade throughout the trading day, updating based on live pricing, with settlement more akin to a stock than traditional open-ended funds. At the margin, costs are likely to be lower, although they do not equate to passive level fees, just because they are ETFs. The lower fees reflect slightly lower running costs due to ETFs not including the costs of advice, marketing, distribution in the way that open-ended equivalents often do.

There are downsides though. Because ETFs cannot close to investors, unlike open-ended funds, strategies with limited capacity are not suitable — one reason why offerings tend to be in large cap assets or more diversified strategies.

Another interesting characteristic is the requirement for transparency of holdings. Many investors will see this as a positive, but it can potentially have its challenges for asset managers seeking to build a position over days or weeks, as other investors may attempt to front run an idea. That said, some of the largest active managers in the US have embraced the trend.

Plenty of listeners may not have even of heard of active ETFs given their lack of coverage. That’s primarily because the tax advantages simply do not exist in Europe. This limits the attraction significantly, but slightly lower costs are not to be sniffed at, whilst many appreciate the shorter settlement periods. The difference in size of the two markets is pretty stark at present, with the US$500bn in the US comparing to around €35bn (US$37.67) in European domiciled assets at year end. For the European market it also seems that there has been more of a bias towards sustainable options than the US market.

One obvious local limiter Is that platforms struggle to deal with ETFs, but there are plenty of market participants that can take advantage.

There has been a definite increase in the noise around active ETFs in Europe in the last twelve months though, with JPMorgan, for example, adding to their range. Another potential catalyst is the arrive of Cathie Wood, the well-known US growth investor, and possibly the most famous proponent of active ETFs via her company Ark. Last year she took a stake in Rize ETF, with the intention of launching ARK ETFs equivalent to her US franchise here. Judging from conversations with a handful of asset managers, there are more product launches in the pipeline for European investors on there way.

If I had to predict, I would say that in the next three years the landscape will begin to change, challenging open-ended funds, asset managers, platforms, and even investment trusts. However, I think it’s unlikely to take off at the speed seen in the US, if only because the financial benefits are not quite as large in Europe.

As ever, we will see in due course.

This is a marketing communication and is not independent investment research. Financial Instruments referred to are not subject to a prohibition on dealing ahead of the dissemination of marketing communications. Any reference to any securities or instruments is not a personal recommendation and it should not be regarded as a solicitation or an offer to buy or sell any securities or instruments mentioned.

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