In the time we have been advising clients on longer term investing, in the pooled fund universe this has mostly meant actively managed funds. However, the changing investment landscape for many of our clients means that new options such as ETFs are now more attractive than before, and while historically investing in ETFs have been primarily about passive investing, this has changed.
For this fifth Insight looking at ETFs (please see Part 1, Part 2, Part 3 and Part 4), we look at the latest types of ETFs, those that are actively managed.
Active ETFs blend the key characteristics of traditional actively managed funds, such as having portfolio managers making discretionary investment decisions, with the benefits of the ETF investment wrapper, such as liquidity and trading flexibility. As their name suggests, they differ from their passive counterparts by using active management to outperform a benchmark or index, rather than just replicate its performance.
Historically, passive ETFs have dominated the market due to their low fees and transparency. However, active ETFs are gaining momentum, driven by demand for higher performance (i.e. alpha generation), innovation in fund structures, and regulatory changes in financial markets.
The active ETF model provides daily liquidity and exchange-traded pricing, features typically absent in pooled (i.e. mutual) funds or unit trusts. It also offers operational advantages such as greater transparency, lower costs, and improved tax efficiency in certain jurisdictions.
While the majority of ETF assets globally still sit in passive ETFs, the active ETF market has seen rapid growth globally, particularly in the US, though it remains relatively new in the UK and Europe. In the US, some of the most popular and sizeable active ETFs include offerings from JP Morgan, ARK, and PIMCO, all of which have assets under management (AuM) of between around $30m and $10m respectively, and have very different investment strategies.
Currently in the UK, active ETFs are less established due to traditional fund dominance, but they are gaining traction. Fund managers including Fidelity, JP Morgan, Franklin Templeton, and Invesco have launched UCITS-compliant active ETFs that are available on UK platforms.
Due to the additional investment resources required, active ETFs typically charge higher fees than passive ETFs, but they are still generally lower than traditional actively managed pooled funds. At present, US active ETFs typically charge between 0.45% – 0.75%, depending on strategy and asset class, while in the UK and Europe they are currently slightly higher due to lower economies of scale at around 0.50% – 0.90%. Some bond-focused or ‘smart-beta’ funds may have lower fees of around 0.30%, while the fees for some niche or thematic active ETFs can exceed 1.0%.
Active ETFs offer many of the same advantages as their passive counterparts, including trading flexibility, cost efficiency, transparency and access to strategies unavailable to some types of investors. Active ETFs can be bought and sold throughout the trading day, just like any listed equity, unlike pooled funds, which are typically priced once daily.
While still costlier than passive ETFs, active ETFs offer much lower costs than traditional actively managed funds, helping to contribute meaningfully to long-term performance. Also, some active ETFs disclose holdings daily, in contrast to monthly, quarterly or semi-annual reporting for traditional funds, helping investors performing due diligence or monitoring concentration risk.
However, of course there are also some challenges and disadvantages to active ETFs. While fees are generally cheaper than traditional actively managed funds, they are still higher than the passive options, and combined with this is the risk that the ETF may not outperform its benchmark. Moreover, being relatively new, these ETF variants do not have a longer-term track record against which to assess performance and therefore the value-for-money of the higher fees.
UK active ETFs can also suffer from lower trading volumes, wider bid-ask spreads, and smaller fund sizes. In addition, not all managers are comfortable with the typical requirement for daily disclosure of their holdings and therefore giving away their investment secrets. However, this has been partially addressed through “semi-transparent ETF” structures in the US, and more recently in Luxembourg and Ireland, but such models are not yet standard in the UK.
Overall, in the UK active ETFs currently represent a growing niche with potential to disrupt some of the dominance of traditional fund structures, providing active portfolio management within modern and efficient fund structures.
For investors seeking better risk-adjusted returns, operational flexibility, and cost control, active ETFs offer a middle ground between passive funds and traditional mutual funds. However, as with all active investing However, due diligence remains paramount, especially around manager style, performance consistency, value for money in terms of fees, and tracking error.
Any readers wishing to get in touch to discuss how our investment advice, including investing in ETFs, could help them please do contact us at info@arlingclose.com.
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