In a banner year for exchange-traded fund flows, actively managed ETFs are taking more than their fair share. According to FactSet Research Systems Inc., active ETFs took in $83 billion, or 17%, of net flows through June 30, despite holding just 3% of the asset base. But just as passive product proliferation in the ETF market has shown that "indexing" is not monolithic, several trends underlie the recent surge in active ETF assets.
First, conversions of mutual funds to ETFs now allow active managers to bring assets, track records and customers wholesale into the ETF structure. With board or shareholder approval, a mutual fund can convert seamlessly to an ETF, provided that it offers daily portfolio transparency. For example, Dimensional Fund Advisors LP used this strategy to convert four tax-managed funds into active ETFs in mid-June. Since converting from mutual funds to ETFs, the funds hold $29.4 billion in aggregate, adding $415 million in net new flows through Aug. 9, FactSet said.
Althea Trevor, Austin, Texas-based head of equity portfolio strategists at Dimensional, said converting these products was a natural fit, given the lower fees and even better tax efficiency offered by the ETF vehicle. She added that commission-free transactions now prevalent on many brokerage platforms and the tax-free conversion from funds to ETFs compounded the benefit to existing shareholders.
Dimensional, which also launched three ETFs from scratch in 2020, plans to convert two more international equity funds to active ETFs in September. And J.P. Morgan Asset Management, which already boasts $64 billion in ETFs across 36 products, recently announced it would convert four mutual funds with $9.7 billion in aggregate assets to ETFs in early 2022.
For ETF issuers not willing to endure the spotlight of daily portfolio transparency, several structures also now exist that facilitate daily creation and redemption of ETF shares while disclosing the full portfolio at least quarterly. Yet, converting from existing mutual funds or launching new ETFs with such features requires specific relief from parts of the Investment Company Act, making it a little more of a process than for funds taking on daily transparency. (Specific exemptive relief is no longer required for daily disclosed products, thanks to the 2019 ETF rule adopted by the U.S. SEC.)
Of 266 active equity ETFs tracked by FactSet, only 39 don't disclose daily, including products from Fidelity Investments, American Century Investments and T. Rowe Price Group.
In April, Capital Group announced it was planning to enter the market with equity and fixed-income ETFs in 2022.
Dave Nadig, CIO and director of research at ETF Flows LLC, has observed financial intermediaries "growing very concerned about sitting around in beta and gravitating toward active, factors and themes." He is skeptical, however, about how well active mutual fund brands transfer to the ETF market.
"The primary market for a lot of these active managers finally entering the ETF space is existing mutual fund and 401(k) customers," Mr. Nadig said. "Conversions are one way to play defense and keep the customers you have. At the end of the day, the products have to solve investor needs."
The second trend boosting active ETF assets is linked to thematic investing, a cross-sector approach that has lifted both active and passive equity ETFs. The products are often highly concentrated and focus on growth, technology and innovation, including emerging industries such as cannabis, blockchain, cybersecurity and artificial intelligence. The $23 billion ARK Innovation ETF from ARK Investment Management LLC is the standard-bearer for this approach, adding $6.6 billion in new assets through Aug. 9.
Capturing alpha, however, remains elusive. Looking at one-, three-, and five-year performance of active equity ETFs, Elisabeth Kashner, vice president and director of global fund analytics at FactSet, found that no products delivered statistically significant outperformance, while a handful underperformed. "The active risk of deviating from the benchmark has not been rewarded," she said.
The third trend carrying active ETFs this year is actually the one that put these products on the map: fixed income. While go-anywhere bond funds from fixed-income luminaries Bill Gross and Jeffrey Gundlach once looked to dominate this category, short- and ultrashort-duration ETFs make up the bulk of the active fixed-income segment, including the $17.6 billion J.P. Morgan Ultra-Short Income ETF and the $14 billion PIMCO Enhanced Short Maturity Active ETF.
"Where cash holding periods exceed nine months, investors may look to ultrashort ETFs for the potential of additional return," said John Tobin, CIO for Dreyfus Cash Investment Strategies, which manages the recently launched BNY Mellon Ultra Short Income ETF. Mr. Tobin sees these products playing a role in building more diversified and flexible cash management strategies, complementing traditional money market funds, by extending duration and investing in non-financial investment-grade securities.
"As investors have increased their level of sophistication, they are demanding a more active approach to cash management,'' Mr. Tobin said. Through June 30, Dreyfus CIS managed $288 billion.
These short and ultrashort products, including those from BlackRock Inc., FirstTrust Advisors L.P., Invesco, State Street Global Advisors, exist just outside the strictures of money market funds, but can serve ETF investors in very much the way that a settlement fund does.
"They trade intraday, so they match the settlement of other ETFs in the portfolio, and they can be easily integrated into model portfolios that may have intraday triggers," ETF Flows' Mr. Nadig said.
