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Active ETFs primed for explosive growth

Agnes King

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The Australian Securities Exchange is poised for an explosion in active exchange traded funds in the next 12 months, as listed investment companies use the vehicle to reverse discounting of underlying assets in their portfolio, while also tapping the popularity of ETFs with new investors.

“We’re bullish on the potential for this product,” ASX general manager of investment products Andrew Campion says. “The majority of new exchange-traded products coming to market in the next 12 months are active ETFs.”

Queenie Tan deployed a ‘core-satellite’ approach earlier this year with passive and active ETFs. 

This is a win for retail investors, according to Equity Mates podcast co-founder Alec Renehan.

He said the big opportunity in the proliferation of active ETFs is the access it gives to everyday investors looking to get some exposure to active management by removing the high minimum investment needed to access unlisted funds.

Investors are also reaping the benefits of more intense competition, according to Craig Wright, head of governance and advisory at Magellan Financial, which pioneered the active ETF market in 2015 and cracked it open further last year with an innovation in its Airlie Australian Share Fund, allowing investors to enter and exit the fund both via the stock exchange and off-market with the registry.

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“Chi-X Australia is now aggressively pursuing the ETF market by offering a streamlined approach to listing applications for managers and an extremely compelling fee offering relative to ASX. CBOE’s acquisition of Chi-X will further accelerate this. ASX will no doubt respond to this competitive pressure and this will lead to lower costs for the industry and more innovation and choice for investors,” Wright says.

New ETF categories and products are win for all investors, says Alec Renehan, of Equity Mates. 

Once a laggard in recognising the attractiveness of ETFs, Australia is now leading the world in terms of innovating to allow active managers to bring products onto the market.

Unlike index-tracking passive ETFs, active ETFs involve a higher degree of curation by a fund manager and carry higher fees as a result.

“An active EFT is really about a portfolio manager or firm trying to differentiate themselves from what the broader market is returning,” says Wright.

Active ETFs currently account for roughly 15 per cent of total funds under management in Australian ETFs. And while passive ETFs are expected to remain dominant as the overall pie expands in the next decade, Campion is confident that active funds will consume a larger slice.

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The ecosystem supporting active ETFs is growing rapidly with many more market makers, unit registries and other providers entering the market or expanding their capabilities.

The ability for active fund managers to bring their investment strategies onto the stock exchange in a way that protects their intellectual property via an active ETF will drive a lot of this growth.

Investors are benefiting from competition among the offerings, says Magellan’s Craig Wright. 

But Geoff Wilson’s new WAR listed investment company highlights other factors at play. “We’re seeing fund managers who operate LICs or LITs change the product to ETFs because there is never a discount or premium to asset value,” Renehan says.

“It has frustrated investors for so long that listed investment companies have traded at a discount to the assets that they hold because they see the asset value growing but don’t see the share price moving in the same way,” he says.

At the same time, in the re-engineering of the wealth management industry following the Hayne royal commission, financial advisers, Campion says, are realising they can build a high-quality institutional grade portfolio for retail clients just using the ASX – and predominantly using exchange-traded products – rather than vertically integrated platforms.

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“There are more investment options in an unlisted managed fund structure but for most people you can still build a very robust portfolio with ETFs,” Morningstar senior analyst Matthew Wilkinson says.

A stable core of passive ETFs can support a strategy of investing in active ETFs, says Vanguard’s Ian Boater. 

Once viewed as arch enemies, there is a growing appreciation that active and passive ETFs can co-exist and, if executed well, grow the overall market.

“The active versus passive strategy is not a binary choice,” Vanguard’s Ian Boater says.

He, like many others, subscribes to the prudence of the so-called “core-satellite” approach, in which passive index-tracking funds act as the “stable core” of the portfolio with complementary active investments.

“They don’t really compete as products,” Wright says. “They’re just offering people different return/risk profiles and can be very complementary.”

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Finfluencer Queenie Tan deployed the ”core-satellite” approach earlier this year, investing $5000 into Cathie Wood’s ARKK Innovation active ETF. She’s down on her investment but went in eyes wide open to the fact that it was a more speculative punt than the rest of her $200,000 portfolio, which is mostly passive ETFs and is up 10 per cent for the year.

“It’s nice to invest in things you really believe in through thematic ETFs. I was drawn to the idea of tech companies changing the world, but they are quite risky,” Tan says.

An emerging risk in the proliferation of active ETFs is investors failing to recognise the difference in the risk profiles and higher fee structure.

“We’ve grown up thinking of ETFs as vanilla index-hugging products with low fees, so it’s crucial investors understand the strategies, fees and risk they’re taking on,” Renehan says.

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Wright argues that risk needs to be assessed with equal rigour on all ETFs, regardless of active or passive, including concentrated index type products and ‘smart beta’ offerings coming to market.

“ASIC is onto this with its new design and distribution obligations. The hurdles are getting higher for people to put product on the market and to ensure that it is going into the hands of the people that it is being developed for,” he says.

Even the potential for some high-profile failures won’t kill the momentum of ETFs, according to Renehan. They are too convenient and offer such accessibility and diversity.

“ETFs will always have a place. Unlisted funds are dinosaurs, with plenty of paperwork and high minimum investments, they are difficult to access compared to other investment options. Getting them on exchange and accessible online was always going to happen and this is the way,” he says.

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