Are Active ETFs the Future of Investing?


Emma Rapaport  |   19th Oct 2018 | 5 min read

Active Exchange-Traded Funds (ETFs) are the latest phase of a passive revolution in the Australian investment market. Last year assets under management in Aussie-listed ETFs grew by more than 30 per cent; proving low cost options are gaining popularity fast.

  Australia's ETF sector broke through the $40 billion barrier in August to reach another new record of $41.5 billion. Just six years ago, funds under management totalled barely $5 billion, according to Morningstar data. Passive ETFs remain the dominant category, capturing 77 per cent of these inflows, according to the BetaShares 2018 Australian ETF Review, while active ETFs made up 16 per cent, a sign that active ETFs are "starting to take hold of the market". An actively managed ETF is a type of exchange-traded-fund that has a portfolio manager who is responsible for selecting and managing the fund's investments, unlike passive ETFs which track the performance of index. Active ETFs typically attempt to outperform the index. Like passive ETFs, active ETFs list and trade on an exchange. Speaking to reporters, Fidelity International managing director Alva Devoy said their new fund was born from concerns that Australian investors, particularly self-managed super fund trustees, are failing to adequately diversify their portfolios beyond cash and Australian equities. Devoy said: "Developing economies offer a fantastic opportunity due to a range of factors such as favourable demographics, the development of the middle classes and increased spending power." “Over the last 20-30 years, we’ve seen emerging market GDP go from 30-40 per cent of global output to almost 60 per cent. In my view, this makes them too big to ignore," portfolio manager Duffy added.

Why an Active ETF?

Devoy pressed that emerging market economies are not without uncertainty and risk, which she says makes active management crucial, but that it was time for active managers to enter the 21st century. "There's a zeitgeist going on in consumerism where your last best experience sets the bar," she says.  "If I buy a leaf blower on Amazon and it’s supposed to arrive on Tuesday and it doesn't, I ring them, and without me having to tell them my date of birth or my maiden name, from my phone number they know my account, they know I've ordered a leaf blower and they know it didn't arrive, and they're set to do something about that. "You put that against trying to get a Telstra line into your house where you had to give your date of birth and maiden name to many different people. Consumers want reduced friction, they want easy access, they want transparency – so the active ETF program was born out of that need in Australia." Fidelity is only the latest in list of asset managers with active ETFs on offer. Magellan was one of the first asset managers to launch an active ETF in Australia, back in March 2015. This was followed by five launches in 2016, and seven in 2017. In 2012, Morningstar's director of manager research Tim Murphy suggested that active ETFs were struggling to gain traction with Australian investors due to structural and regulatory issues. "One of the benefits of pure passive ETFs is the increased transparency, so publishing daily what the portfolio managers are up to. Most active managers out there complain about having to provide that level of transparency to the market, and fear about being front run," Murphy said, meaning fund managers were wary of other investors emulating their portfolios for free. "There's certainly some asset classes, such as small caps, where that would be a valid concern." At the time, PIMCO had just launched an ETF version of the world's largest mutual fund, the PIMCO total return fund, and Murphy said this would be a "litmus test" for whether active management could work inside an ETF structure.

Full Disclosure

While US funds are required to fully disclose portfolios on a daily basis, there is currently no such requirement in Australia, with only the top-10 underlying assets required to be disclosed. Fidelity appears to have succeeded in addressing these structural issues, helped in part by innovative disclosure procedures developed by the ASX. "Regulators and the exchange knew that we would come to a juncture where the layering of risk amongst individual investors, especially to Australian property prices, could potentially become a problem, so they were working years ago on mechanisms to help clients diversify their investments," Devoy says. "The ASX is the only exchange currently that provides a mechanism to us to list without providing our holdings on a daily basis. It's a very elegant solution." The Fidelity Active ETF Global Emerging Markets Fund will aim disclose its holdings on a quarterly basis.

Advantages and Disadvantages

Some of the advantages of active ETFs, compared to unlisted managed funds, include a more efficient investing process, with trading conducted through a broker or online trading service such as CommSec or eTrade. However, there are drawbacks to active ETFs. Active ETPs in Australia can cost more than their unlisted counterparts and passive products. For example, Magellan charges the same fee of 1.35 per cent for MGE as its unlisted fund Magellan Global Equities, and K2 charges a steep 2 per cent for the K2 Global Equities Fund (ASX: KII) and the K2 Australian Small Cap Fund (ASX: KSM). According to Morningstar manager research analyst, Anshula Venkataraman, "it's reasonable to expect active ETPs to charge higher management fees than passive ETFs but be aware that it may also cost more to buy and sell an active ETP". She warns that unlike an unlisted fund, investors will have to pay brokerage. And in contrast to passive ETFs, bid/ask spreads for active ETPs are typically higher.

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