Anne-Valère Amo: Active ETFs – Growth, Challenges, and the Need for Rigorous Due Diligence

All eyes on active ETFs

Not tracking an underlying index, active ETFs are garnering ETF issuer and mutual fund manager attention as a growth opportunity as they target new audiences like digital platforms, offer tax advantages (especially for US equities), and leverage dual market liquidity. Today’s active ETF landscape is accessible through two channels: launched on a dedicated and proven platform (see J.P. Morgan AM’s success story), or wrapped through a white-labelled ETF in partnership with existing issuers. While indeed a turnkey solution, the latter channel adds layers of fees, and relies on partner reputations, distribution channels, and brand impact.

To be or not to be active

Fund managers entering the active ETF market face two opposing growth strategies: competing on fees by offering the lowest TER or focusing on innovation. Active ETFs fall into the latter category, although fund selectors will inevitably compare these to low-cost passive ETFs. Mutual fund managers cloning their strategies into an ETF wrapper could also face (asset) cannibalization risk, especially if pricing differs. European regulations currently require daily fund transparency, exposing active strategies to front-running risk. Though it may ease, this requirement aims to help liquidity providers effectively price ETFs intraday and maintain tight trading spreads. Importantly, since their 2019 approval in the US, active non-transparent ETFs (ANTs) have not attracted the expected assets, while transparent active ETFs still hold a larger market share. Lastly, certain illiquid strategies could face capacity constraints when offered through an ETF structure, since ETFs cannot restrict new investors like mutual funds can.

A lasting trend? Follow the flows

Active ETFs have seen stronger growth in North America, with AuM reaching USD 860 billion versus USD 46 billion in Europe. Controlling 39.7% of active ETF assets, US players like Dimensional, J.P. Morgan AM, and First Trust lead the North American market. In Europe, J.P. Morgan AM dominates market share (53.5%), followed by PIMCO (10.9%), and Fidelity (10.1%). Despite starting later, Europe's active ETF market is gaining momentum with a 40% year-to-date asset growth and USD 9 billion in net inflows, driven by expected regulatory changes, mutual fund manager interest in broader audiences, and increased investor awareness. However, compared to the overall size of the European ETF market, active ETFs make up just 2% of the total assets, with J.P. Morgan AM capturing 90% of 2024 inflows (as at 23 August 2024; source: Trackinsight).

Know your ETFs

ETFs have long been assimilated to pure passive strategies, where assets under management have often competed with those of mutual funds, prompting the endless debate between active versus passive management. The advent and expansion of active ETFs should put an end to this historical debate – again highlighting the need to consider them as funds managed by an asset manager whose investment philosophy and process, risk management, etc., must be mastered through comprehensive due diligence prior to investing.

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