Traditionally, exchange-traded funds have been seen as wholly passive products, set up to give investors cheap, accessible and transparent access to the world’s biggest markets.

Over time this market has developed to include products tracking niches, sectors and themes and the latest leg in their development is the actively managed ETF – which does not just follow an index but instead has a professional at the helm constructing a tailor-made portfolio.

In this article we will examine what an active ETF is, the pros and cons of this type of product, look at some examples and explore how this space might develop over time.

WHAT IS AN ACTIVELY-MANAGED ETF?

‘An active ETF resembles a traditional actively managed mutual fund, but the ETF product trades on an exchange with the benefits of the ETF structure,’ says Jason Xavier, head of EMEA ETF Capital Markets at Franklin Templeton.

‘Active management doesn’t have the constraints of tracking an index, which means an active manager can choose which stocks or bonds to buy, when to buy, when to buy them and at what size/price.

‘In an effort to outperform its portfolio index, fund managers can actively respond to market events and adjust allocations amid changing market environments. In some instances, they even have some leeway to invest outside the confines of their benchmark index.’

There has been nothing necessarily stopping providers from offering active ETFs since the inception of these products more than two decades ago but one big obstacle was removed in the US with a regulatory change in 2019.

Fund managers often like to closely guard a full list of their holdings for fear a rival or individual investor might simply piggy-back on their success by copying their approach. In other words, they do not want to give away the secret ingredients behind their success.

This is at odds with ETFs’ mandated transparency, where they must disclose all their holdings on daily basis. In 2019 the US flexed the rules to allow semi-transparency, with the underlying holdings obscured by proxy holdings, for example.

There is currently no such flexibility in Europe and before 2022, investors were not able to trade actively managed ETFs at all in Japan, until the Tokyo Stock Exchange announced that it would allow active ETFs with daily transparency to become listed in the second half of 2023.

A RAPIDLY GROWING MARKET

Mainly, though not exclusively, in the US the active ETF market has been growing rapidly and while they remain just 5.3% of total assets invested in global ETFs, they saw inflows of $60 billion in the first half of 2023.

Edward Malcolm, UK head of ETF distribution for JPMorgan Asset Management, says: ‘The UK and Europe actively managed ETFs market is very much a growing sector. We [JPMorgan] now have 18 actively managed ETFs in the UK and Europe, compared to the US where there are 27 and currently have global assets under management of £130 billion.’

A key attraction of ETFs, beyond the transparency and liquidity provided by their market listing, is their cost. The typical active equity fund costs around 0.7 percentage points more per year than an ETF. However, simple ETF trackers obviously don’t have the extra costs which come with paying a team of professionals to manage a portfolio.

As JPMorgan’s Malcom says: ‘ETFs offer investors flexibility with trading, transparency and lower costs.’

It is relatively early days for actively managed ETFs on the UK market and therefore difficult to judge their performance, for this area to really take off it may require the sort of regulatory changes seen across the Atlantic.

SNAPSHOT OF AN ACTIVE ETF 

Callum Abbot is one four portfolio managers of the JPMorgan UK Equity Core UCITS ETF (JUKC) – an actively managed ETF launched on 14 June 2022 with an ongoing charge of 0.25%.

It has produced an annualised return of 6.85% since launch compared to a 6.96% annualised return of its benchmark the FTSE All-Share Index.

Abbot rebalances the portfolio monthly using a ‘core investment process’ and the named fund managers have a team-based approach.

The top 10 holdings reflect the benchmark index, with some of the largest holdings in AstraZeneca (AZN), energy giant Shell (SHELL), HSBC (HSBC) and Unilever (ULVR).

According to its factsheet a typical investor for this JPMorgan ETF is one who ‘wants to take broad market exposure to the UK stock market, who seek to benefit from potential excess returns after fees with similar risks to investing in securities representing the benchmark.’

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