Summary
- Active ETFs allow investors to earn better return than the benchmark index as it is monitored by fund managers
- In Australia, the Active ETF market is 5 years old and make up only 2% of the total regulated managed fund industry FUM
- With the five and ½ month ban on Active ETFs being lifted by ASCI, the ETF market is set for a boom in Australia, providing opportunities galore to Active managers
ETFs have gained quite a market in the investment world since been introduced in 1990s. They generally follow an index and provide a low-cost diversified return option. An ETF benchmarking a top performer index is generally considered safe to invest in and the returns mirror the index. ETFs can be passive as well as active. A passive ETF generally follows an index with no sector rotation. An active ETF allows a manager to add stock market components such as market timing and sector allocation to the trading and aim for higher returns.
Let us dig deeper to understand Active ETF and how it is expected to perform amid the ‘FOMO’ World.
What is Active ETF?
Exchange Traded Funds (ETFs) which are managed by a portfolio manager is called an Active ETF. An Active ETF follows an index or a mutual fund with the flexibility to allow intra-day trading by investors i.e. investment instruments bought and sold during the day’s trading time. The intraday trading feature enables investors to earn profit through quick shifts, as against trading the mutual fund. Having a portfolio manager facilitates better than average results as managers have the ability to shuffle sector allocations or deviate from the benchmark index by tapping in top investor picks in the portfolio. Hence an active ETF may not produce investment returns mirroring the underlying index.
When Active ETF’s looks more attractive during FOMO economy?
In todays’ economy, where the market changes its course with every positive and negative announcement, the returns on investment have also become unpredictable. Volatility in the market actually acts as a boon when it comes to Active ETF returns. A fund manager can easily shift assets or sector allocations if the ETF is underperforming.
The 10 year old Australian ETF market has been booming staggeringly with ETF assets growing at 23% CAGR for the past five years. According to Vanguard, the ETF market crossed $61b in assets under management (AUM) in Australia in 2019 with inflows reaching $13.7 billion. ETF industry inflows were $8.0 billion in 2017 and $6.4 billion in 2018. Further, new ETF inflows in the first quarter of 2020 were $3.8 billion, as per Vanguard.
It has been five years since active ETF has been launched. According to the ICI 2019 annual factbook, ETFs make up only 2% of the total regulated managed fund industry FUM in Australia. In December 2019, ASIC had lifted its ban on opaque active ETFs and allowed them to be listed on Australia’s two exchanges, with a condition that active ETF providers must comply with new guidelines. The lifting of a 5 and ½ months ban in late December has opened a gateway for the listing of more ETFs in the Australian market and creating more opportunities for active fund managers.
Total Returns of Vanguard Global Value Equity Active ETF (VVLU) (Managed Fund)
Source: vanguard investments
If we look at the Total Returns of Vanguard Global Value Equity Active ETF with respect to the benchmark, FTSE Developed All-Cap in Australian dollars Index, the benchmark index fared better with respect to VVLU.
As at date 31 May 2020, VVLU had 1,194 number of holdings whereas the benchmark has 5632 number of holdings. The Equity yield (dividend) was 4.07% for VVLU and whereas Equity yield was 2.41% for the benchmark index.
Benefits of Active ETFs are a good option for Long-term investment?
- Active ETFs allow investors to earn better return than the benchmark index it is tracking as fund managers have the flexibility to allocate different sectors in case the benchmark index is underperforming
- Active ETFs allow low cost investment opportunity and lower expense ratio with respect to mutual funds or index or other actively managed funds
- Active ETFs allow diversification under one portfolio which spreads the risk creating a safe bucket to invest
- Active ETFs are traded during the stock exchange operating hours and allow pricing and continuous trading like ordinary shares
- Intraday trading allows returns in short shifts and access to quick liquidity
- The fund manager has to maintain transparency by providing details of the ETF basket and it’s Net Asset Value (NAV) on daily basis. This NAV information helps investors to track performance of the ETF.
- Active ETFs are tax efficient, as the funds do not draw capital gains.
Limitations of an Actively Managed ETF
- Active ETFS are more expensive than the passive ETFs as they also have fund managers who are responsible to provide higher returns or make the ETF outperform. So ideally an active ETF will have a higher expense ratio than a passive ETF.
- Active ETFS tend to be riskier as the fund managers keep shuffling stocks for the ETF outperform. This may lead to more exposure to risk for the active ETF portfolio with the allocations backfiring.
- An active ETF is less diversified than a passive ETF with fund manager shifting allocation as per the performance of the ETF and market conditions.