Exchange-traded funds are, by their very nature (usually), passive investments because they track an index, bonds, commodity or other asset, or so the average investor might think. However, the rise in ETFs as investors shun active investing methods in favor of passive ones has spurred growth in this lesser-known breed: actively-managed ETFs.
It seems active managers are attempting to cash in on the ETF trend, and Moody’s Investors Service notes that they have plenty. In fact, Precidian is patenting a new type of technology that will allow active managers to more easily take advantage of the ETF trend.
Investors starting to shun active investing
Passive funds have dominated the ETF space, so much so that the average investor may easily be led to believe that all ETFs are by definition passive investments, but that’s simply not the case.
“Investors may assume index funds and ETFs simply replicate the chosen index they wish to track,” Wealthramp founder and investor educator Pam Krueger told ValueWalk in an email. “Alternative strategies including smart indexing, or simply placing different weights on certain sectors may deviate from that mission. It’s easy to see how investors can be confused and why transparency and educating investors is essential.”
Passive funds tend to be less expensive and more transparent than active funds, and the Department of Labor’s Fiduciary Rule has called attention to some faults that are common in the active investing space, particularly when it comes to transparency. The rule requires financial advisors to act in their clients’ best interest instead of trying to sell them the funds that bring them the highest commission.
Actively-managed ETFs on the rise
Thus, many investors have sought shelter in ETFs, and the danger is that some may think that all ETFs are passive and therefore a safer investment than other types of funds. But the number of actively-managed ETFs is on the rise, making it increasingly likely that the average investor will stumble across them. Actively-managed ETFs aren’t necessarily a bad thing — as long as investors know what they’re getting.
As of April, the ETF industry reached $4 trillion in assets, a new record based on data from ETFGI and reported on by MarketWatch. In April alone, ETFs racked up almost $38 billion in inflows. Bank of New York Mellon executive Frank La Salla predicts a $10 trillion ETF market by 2020 “because of the unique structure of ETs, and because of advisors being held to higher standards,” MarketWatch reported in October.
With such a large amount of growth projected for ETFs as a whole, it should come as no surprise that the number of actively-managed ETFs is rising rapidly because active managers want a piece of the pie. According to Zacks (via Seeking Alpha), there are now 188 unleveraged actively-managed ETFs with almost $36.18 billion in assets under management. Although that isn’t very many, the number has more than doubled since 2013.
How actively-managed ETFs can benefit
So with investors increasingly seeking out ETFs, offering actively-managed ETFs makes sense for active asset managers, and Moody’s Investors Service analyst Neal Epstein noted recently that some new ETF technology will help them with this endeavor.
He pointed to Nationwide Investment Services’ negotiations to license the new ETF technology developed by Precidian Investments and stated that wider use of actively-managed ETFs “would be credit positive for active asset managers.” Epstein estimates that actively-managed ETFs make up only 1% of the ETF industry and noted that this leaves “considerable opportunity for active managers to increase their share of the ETF market.”
Precidian’s patent is for proprietary technology that “would enable active managers to use the ETF vehicle without disclosing the holdings of their funds’ portfolios. Precidian’s approach creates a “confidential account” so that “authorized participants” in the actively-managed ETF cannot see the exact mix of the assets are in it.
Epstein summed up by hitting on one of the key problems active managers are having because the DoL’s fiduciary rule requires them to be transparent about their fees: “If active managers were to distribute their products in ETFs, their management fees would be under less pressure, allowing them to benefit from both increased volume and pricing.”