Economy

New Products: The Invasion of Actively Managed ETFs

The world of finance and asset management is not particularly known for its capacity for innovation. Companies in other sectors are much better at creating new, sometimes revolutionary, products that are able to better satisfy the needs of consumers, to accommodate their habits, sometimes to change our own behaviors.

For “us” the fundamental need of the Client has not changed much over time, remaining that of seeing the capital available safeguarded and made profitable based on the degree of risk / volatility that one is able to bear and the time horizon that one has in front of one. If you think about it, all the products that have been created, from asset management, to funds, from policies to ETFs (exchange traded funds or passive funds for those who do not speak the jargon of the markets) have the objective of satisfying this need in one way or another.

It is also true, however, that every now and then some semblance of novelty arrives. And so today we tell you about actively managed ETFs, the latest frontier of our world, at least on the listed markets side.

Active ETFs combine the classic characteristics of ETFs (listing on the stock exchange, “replicating” a market index, low management fees) with one typical of classic mutual funds or SICAVs (the objective of beating a benchmark through active management).

A nice image produced by JPM Asset Management helps us to show how these two things mix together.

Active ETFs are a “middle way” between normal ETFs / Index Funds and actively managed funds / SICAVs. They try to systematically beat the benchmark through active management that has a small alpha target (in jargon the positive difference between the product’s performance and the reference parameter or benchmark), but also a very low tracking error (variability of performance compared to that of the benchmark). In practice this means that the freedom to detach itself greatly from the benchmark, which exists in true active funds, is drastically reduced; this should avoid, and so far has been the case, cases of high underperformance (or negative alpha). On the cost side, we are talking about products that cost more than normal ETFs, but much less than active funds.

In practice, the management of active ETFs is typically quantitative and there is little discretionary component (the only way to contain the tracking error within the established limits). All producers declare that they use algorithms created by them. Often in addition there is a “qualitative” component typically based on the research that these asset managers do internally and that allows them to have opinions and ideas on companies, bond issues, currencies, etc.

The market for these products in the United States, but also recently in Europe, is growing a lot. They are popular products that are very “pushed” by those who are proposing them to investors. Today the European market is worth around 35 billion euros and has multiplied fivefold from 2019 to today. This figure is worth only 2% of the masses invested in “normal” ETFs, but it is destined to rise a lot given that the growth rate is 35% average per year, much higher than that of the general ETF market as shown by the Banca Patrimoni Sella & C processing on JPM data.

Who are the players riding this boom? To date, large American and European asset managers that typically do active management, including JPM AM, Pimco, Fidelity, Capital Group on the US side and Amundi, HSBC, AXA on the European side. The trend of passive management compared to active management seems to be inexorable and this year the overtaking in terms of market share at a global level has occurred, as you can see in the Goldman Sachs chart. The fact that even large players known for their research and decades of active management (with success rates in producing alpha that are on average low, it must be said) have thrown themselves into active ETFs is, in our opinion, a very strong signal.

But are these active ETFs valid? The answer is based on what we have seen so far in the track record of 4 or 5 operators that has a duration varying from 3 to 7 years and will therefore need to be re-evaluated in the future. Keep in mind that today in Europe there are less than a hundred products on the market, although in strong growth as mentioned.

Here she is:

  • The percentage of active ETFs beating the benchmark is much higher than that of active funds. We are talking about doing from a few basis points better to 1 percentage point in order of magnitude.
  • The low tracking error set has so far been almost always fully respected.
  • The low cost helps to create extra performance (alpha) and is a basic advantage compared to traditional funds and SICAVs with a higher TER.
  • In the “grace” years, good active managers can produce much higher alpha. The problem typically remains that of temporal persistence.