Deep Dive: Active ETFs Are Set To Drive Growth For The ETF Industry

Europe-domiciled active ETFs have gone from year-end assets under management of €8.7bn to €34.9bn in the past five years and, as of 2023 so far, they have enjoyed an organic growth rate of 22.3%, according to data from Morningstar Direct.

The growth is also represented in the Europe-domiciled ETF market share, with active ETFs' share growing from 1.3% to 2.3% since 2018.

Travis Spence, head of EMEA ETF distribution at JP Morgan Asset Management, expects this trend to continue: "We view actively managed ETFs as one of the major drivers of growth in the ETF industry going forward".


James Penny, chief investment officer at TAM Asset Management, said the benefits of active ETFs, such as allowing clients to enjoy the lower costs of ETFs while benefitting from the active approach, was a primary reason for this growth.

"This active element can help them navigate a new market cycle that will undoubtedly require a more active approach as the market acclimatises to inflation and higher interest rates," he said.

Spence argued the active management element of the portfolios could also produce better investment outcomes, especially in areas concerning ESG, as "active research inputs can take into account material ESG factors, combined with engagement".

Investors prefer active ETFs while fixed income flows dominate in H1 2023

Euan Anderson, real estate investment director at abrdn, noted that active ETFs can open up a "wider investment universe", as they provide investors with increased flexibility, which can be beneficial to specific asset classes, such as global listed real estate.

A primary differentiator from passive ETFs for Titan Asset Management CIO John Leiper is the ability of portfolio managers to adjust the holdings of active ETFs without being subject to the "rules and constraints" of tracking an underlying index.

"This introduces a variable component to performance, predicated on the manager's ability to outperform the benchmark," he said.

He also highlighted another key benefit in providing the opportunity to deploy capital "quickly to accommodate changing market conditions", and potential tax benefits in certain jurisdictions.

Active ETFs vs mutual funds

Active ETFs are not just attracting existing ETF buyers, Spence said, noting that mutual fund users were increasingly embracing the product alongside their traditional active options.

Anderson said: "The active element allows the manager to tilt portfolio exposures in favour of preferred markets and sectors, and conversely, move to an underweight position in less favoured areas of the market which are expected to continue to come under structural pressures over the longer term."

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Leiper noted that while active ETFs tend to be more expensive than their passive counterparts, they are often cheaper than comparable mutual funds, while also benefitting from "enhanced" liquidity.

Piera Elisa Grassi, research enhanced index equity portfolio manager at JP Morgan Asset Management, said she utilised active ETFs within the firm's equity portfolios.

In these active ETF managers can see long-term trends and adjust holdings on that basis, Grassi said, such as the diverging valuations in the US equity market.

She explained that the US equity large-cap market returns through September were largely driven by the narrow market leadership of seven large companies, which had driven their valuations higher. But the valuation spread between the cheapest and most expensive quintile is 22% higher than the average of the last 25 years.

ETF demand remains high as active popularity continues to surge

"This is key as it allows us to identify more attractively valued companies from the rest of the market and overweight these stocks versus the benchmark," she said.

Spence explained the choice between active ETFs and mutual funds comes down to investor preference.

"For some professional investors, daily portfolio transparency may be their number one priority. On the other hand, a mutual fund may, for example, fit an investor's operational infrastructure better," he said.

Possible challenges

Leiper said the benefits of an active ETF could be diminished by the requirements for daily disclosure, as this could alert front-runners and other traders in the market. However, the advent of semi-transparent ETFs, which can disclose their holdings quarterly rather than daily, could be a possible solution for this.

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Penny added that showing the ability of active ETFs to deliver reliable outperformance will be the key to investors accustomed to the lower cost of passive ETFs adopting them.

"The ability of an active ETF to consistently outperform needs to be established thorough due diligence, exceeding the level of scrutiny applied to pure passive ETFs," he said.

Leiper added: "Whether that performance actually transpires is in the hands of the portfolio manager and, ultimately, the fund selector."


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