What are the key structural trends driving interest in Active ETFs? We examine this question in light of ETF product growth, advisor demand and a focus on fees.
The prolonged equity bull market and low interest rate environment have driven tremendous investor interest to exchange-traded fund (ETF) products as investors seek returns, low fees and transparency. Notable in the first and second quarters of 2018 were asset flows into Active ETF products—ETFs with a portfolio manager making portfolio allocation decisions in lieu of passively tracking an index—as investors seek higher returns, portfolio diversification and prepare for potential market volatility ahead.
According to an analysis by Intermediary Analytics, assets in Active ETFs, which comprise approximately 3% of total ETF assets, grew 43% over the past eight quarters through the second quarter of 2018, as shown in Exhibit 1. This compares to 23% growth for Index ETFs and 18% for Smart Beta ETFs.
Source: BNY Mellon Intermediary AnalyticsSM
As the second half of 2018 progresses, we anticipate more interest in Active ETFs due primarily to three key structural trends driving this interest as asset managers consider expanding their product offerings in this category.
The growth of ETFs as an investment vehicle is driving demand for new products to meet the diverse needs of institutional and retail investors. Investors have been attracted to the lower fee structure and exchange-traded qualities of ETFs, evidenced by the large fund flows into these products over the previous decade.
While the largest providers of ETFs, such as BlackRock’s iShares, Vanguard and State Street Global Advisors dominate the purely passive index-tracking product sets, other asset managers see opportunity to package their well-known investment strategies into ETF structures. One such group are active managers who are increasingly launching ETFs as part of product lineup due to the appeal of ETFs to investors seeking lower-cost investments than found in traditional mutual funds.
Jeff McCarthy, BNY Mellon’s chief executive officer of ETFs, also sees ETFs and mutual funds moving toward a convergence, saying, “The differences between ETFs and mutual funds are becoming less obvious as managers launch more ETF products that use active management strategies. This trend puts increasing pressure on both ETF and mutual fund managers to carefully consider their overall product strategy to stay competitive.”
Additionally, under the newly proposed SEC Rule 6c-11, if approved, ETFs that meet structural, transparency and disclosure requirements would be able to launch without first seeking exemptive relief from portions of the Investment Company Act of 1940. Like many investment industry analysts, we believe this rule will help to facilitate a market environment more favorable to Active ETFs.
Financial advisors are driving the demand for new and different products under the specter of fund product rationalization and shrinking shelf space. Systemic shifts in mutual fund distribution—such as elimination of sales loads and more scrutiny on fiduciary best practices—have advisors seeking lower-cost fund structures that offer similar investor exposure and returns. As advisors seek alpha amid rising interest rates and market volatility, they are increasingly turning to Active ETF products. In particular, Rep-as-PM advisors—those with full discretion over their clients’ investments—comprise more than half (53%) of all Active ETF assets executed on Rep-as-PM platforms.
Additionally, investors are seeking investment products that align with other types of investor interests—such as environmental, social and governance (ESG) investing—typically underrepresented in passively managed index products.
Investors across the financial landscape—from large institutions to retail investors—are focusing more on the fees they pay for investment products, and the impact of those fees on the overall performance of their investments. Lower fees have been a key selling point for Index ETFs as broad stock indexes have performed well, igniting a conversation across the financial industry about expense ratios for fund management. Asset managers are responding with Active ETF products that team of investment professionals manage, similar to mutual funds but with lower expense ratios.
We anticipate more Active ETF launches as these three trends continue. However, macroeconomic and market trends—such as rising interest rates, a prolonged market slump or geopolitical events—may drive demand for new products in the future. Asset managers should remain nimble to respond quickly to these factors in designing investment products that meet future investor demand.
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Vice President, Research, BNY Mellon Intermediary Analytics
Scott is responsible for all Intermediary Analytics research and custom analysis delivered to clients in the form of industry summaries, presentations and special reports.View Profile