Following a boom in the United States, exchange traded funds based on stock selection are making inroads into Europe.
According to Morningstar Direct data, so-called active ETFs — which invest in equities chosen by a manager rather than passively tracking an index — have garnered investor inflows in each of the last seven quarters, bringing total assets to €30.7 billion.
In comparison, active mutual funds in Europe have leaked money in six of the last seven quarters, with a total of €340 billion of the €8 trillion invested in mutual funds heading out the door.
The breakthrough may aid traditional active fund managers in their battle against the swelling wave of low-cost passive index-tracking funds, though they will have to accept reduced fees.
“A lot of managers have missed the big passive ETF wave and are trying to jump on the bandwagon,” said Richard Bruyère, managing partner at consultancy Indefi. “Europe has quietly emerged as an untapped opportunity.”
“Active ETFs have been a breakthrough story [in Europe] this year,” said Travis Spence, JPMorgan Asset Management’s head of ETF distribution, Emea. “We are at a tipping point where ETFs are not just about passive anymore.”
ETFs first appeared in the 1990s as simple, low-cost index-tracking products. Traditional active fund managers, who typically offer mutual funds, have joined on board in recent years.
The tendency has been especially visible in the United States, where ETFs receive preferential tax treatment over mutual funds. According to JPMAM, actively managed funds represent for 5% of the $7.5 billion US ETF market but 25% of this year’s net inflows.
Europe, which has a level playing field in terms of tax treatment, has lagged but now appears to be following suit.
“ETFs have grown at a rate of 20 percent per year in Europe.” “The active part has grown at a CAGR [compound annual growth rate] of 35%,” Spence said.
JPMAM has set the standard in Europe. According to Morningstar, it has taken the top two spots in the flows chart for the first nine months of the year with its US (JREU) and Global (JREG) Research Enhanced Equity (ESG) Ucits ETFs, as well as a further nine slots in the top 30.
Other firms with inflows into actively managed ETFs include Fidelity International, Pimco, Axa, WisdomTree, Investlinx, and Franklin Templeton.
This activity is attracting competitors, with Cathie Wood’s Ark invest announcing a European push through the acquisition of Rize ETF and Dutch asset manager Robeco announcing preparations for its first ETFs.
“It’s a natural space to expand for traditional managers,” he said. Client demand, he added, was one factor, because “ETFs are traditionally priced more cheaply than mutual funds and are well suited to the digital channels” that are emerging in Europe and challenging the traditional means of marketing ETFs, through banks or insurance firms.
Because, unlike mutual funds, ETFs do not pay “rebates” to distributors, they are frequently excluded from these traditional distribution networks.
“Investors who use digital platforms are more cost conscious, and purchasing an ETF is simpler than purchasing a traditional mutual fund.” “Gen Z [investors] want a good customer experience,” Bruyere remarked.
ETFs, according to Spence, are frequently employed by institutional investors such as pension funds, central banks, and sovereign wealth funds.
“We are at the start of the retail segment in Europe,” he added, noting that retail presently accounts for less than a fifth of the market.
“That will play a much larger role in the future.” This will result in a slew of new solutions. Historically, retail has been quite supportive of active strategies. This is a revolution in the ETF sector, in our opinion.”
According to Nizam Hamid, an independent ETF consultant who previously served as the head of ETF strategy for both Société Générale and WisdomTree Europe, digital platforms are the “future of distribution,” therefore appearing on them helps traditional fund managers to “cover all the bases.”
“Robo-advisers: that’s where you want to be if you’re looking out 10 years.” “You should have something on the shelf in that space,” he suggested.
Spence listed the benefits of ETFs as “transparency, price discovery, the ability to trade daily and intraday, and of course price.”
“Investors have become more comfortable with using ETFs in their portfolios,” he said. “As more active strategies become available, they are shifting” to utilizing ETFs alongside mutual funds.
JPMAM sees a “big opportunity” in fixed income, which “generally warrants an active approach due to the way the bond indices are structured,” according to Spence, with the most indebted corporations and nations receiving the greatest weights.
Hamid predicted that additional expansion would be difficult, particularly for active ETFs that are unable to outperform the underlying market.
Furthermore, an ETF clone of a mutual fund is likely to have lower costs, potentially resulting in costly outflows from the latter.
Traditional managers had to question themselves, “Do you want people to change? Do you want others to think our pricing is unusual?” Hamid stated. “You bring upon yourself fee compression and if you can’t generate alpha [outperformance] what is the point?”
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