Active ETFs

Overview of the Active ETF market

The year 2018 has provided much empirical evidence to demonstrate the growing attraction of ETFs. In fact, October 2018 was the 48th consecutive month of net inflows into ETFs, with the total assets under management at the end of the month being $744m, even in spite of a turbulent month for the markets that proceeded. Investors have flocked to ETFs to avail of their low total expense ratios, high liquidity and transparency of holdings, as well as its potential to match or exceed the performance of the relevant benchmark.

Accounting for $106bn of the overall assets under management of ETFs are Active ETFs. For the period ending in October 2018, the assets under management of Active ETFs themselves have increased by over 32% during 2018.

The investment manager of an Active ETF makes investment decisions which result in the underlying portfolio allocation not following a passive investment strategy. An actively managed ETF will have a benchmark index, but managers may change sector allocations, market-time trades or deviate from the index as they see fit.

The most popular Active ETFs are currently fixed income ETFs, in particular the PIMCO Enhanced Short Maturity Active ETF which has assets under management of $11.2billion. The strategy of the fund is to out-perform the average money market mutual fund whilst investing in high-quality, short-term debt. Should an investor deem market volatility to be too much of a threat to their assets, investing money into a liquid alternative to a money market mutual fund is an attractive proposition.

Drivers for growth in ETFs

The significant growth in the assets under management of Active ETFs is the result of an evolution of the environment in which they operate. Whilst Passive ETFs must, by their inherent nature, carry a portfolio which is relative to their benchmark and, more specifically, the market-cap of the investments within that benchmark, actively managed ETFs offer their managers with more scope to employ innovation in an attempt to beat the performance of the index.

Employing innovation in stock picking is a trend which is likely to see Active ETFs experiencing further growth over the coming years. The advent of Robotic Process Automation has infiltrated the ETF market with Robo Advisors becoming a key part of the ETF strategy for both Passive and, in particular, Active ETF management. Asset managers such as BlackRock, Lyxor, Morgan Stanley and Charles Schwab have invested in Robo Advisors. In Active ETFs, the Robo Advisor perform crucial tasks such as ongoing data collection and analysis of the market, as well as proposing shifts in asset allocation away from those which would be prescribed through a normal Passive model. All of this is to outperform the market.

On 21 March 2018, BlackRock launched 7 ETFs, together known as ‘iShares Evolved.’ These Active ETFs utilise data science techniques, including machine learning algorithms and text analysis, to categorise and choose companies for their portfolios. In essence, the investment decisions are made by artificial intelligence.

Technology and innovation

Innovation and innovative companies themselves are also an attractive proposition for Active ETF stockpickers and analysts. During 2017, tech giants Facebook, Apple, Amazon, Netflix and Google (collectively referred to as “FAANG”) saw an average increase in share price of 48%, making them staples of Active ETF portfolios to a greater degree than would be possible for a passively managed S&P 500 ETF.

Active ETFs have the opportunity to weight their portfolio in favour or against recognised technology companies but can also allocate assets towards the most cutting-edge technology that may present a higher level of risk but may also generate very strong returns. A prime example of this is the ETF.com ‘ETF of the Year 2017’, ARK Innovation ETF. ARK Innovation ETF focuses on companies involved in disruptive innovation. To this end, the portfolio’s top weighted equities include Statasys Limited (3D printer manufacturers), Tesla Inc. (electric vehicle producer) and Intellia Therapeutics Inc. (biotherapeutics company developing gene editing systems). ARK Innovation ETF generated an increase net asset value per share in 2017 of 87%.

Whilst the ETF market continues its unprecedented growth, the storyline of the Active ETF makes for intriguing viewing.