ETFs are perhaps one of the most significant financial innovations of the last 30 years, synonymous with the growth of passive fund management. As such, ETFs are often viewed exclusively as passive investment vehicles. However, dig a little deeper, and you will find that this is not the case. Furthermore, given recent regulatory developments, future growth in ETFs could be fuelled more significantly by active managers adopting the ETF structure.
In the last two years, firms including Fidelity, JP Morgan, American Century, T Rowe Price, Legg Mason and Natixis have launched active ETFs. In fact, in the US this year (a market generally two to five years ahead of Europe), launches of active ETFs have outnumbered launches of passives.
In this article, Alpha considers what has changed and how more managers could come to view ETFs as an opportunity, not a threat.
#1: The Distribution Opportunity
ETFs trade intra-day on exchanges and through other platforms, providing instant access to a broad range of asset classes and regions. Institutional and retail investors alike appreciate the ability to access fund exposure quickly, and at a known price, in a more efficient manner than traditional mutual funds. ETFs have already disrupted the way in which we access fund exposure, becoming the preferred implementation vehicle for many investor types. Active managers may wish to consider their response to this change in client preference.
#2: The ETF Share Class Opportunity
In recent years, regulatory developments have made it possible to launch an ETF share class of an existing mutual fund. European managers can take an established fund, with scale and track history, and launch an ETF share class of it. This satisfies the needs of investors who may prefer the access and liquidity benefits of ETFs over mutual funds. Furthermore, launching an ETF share class of an established fund enables the manager to enter the ETF market with a proven, viable product.
#3 The Non-Disclosure Opportunity
In Europe, ETFs are generally required to disclose their holdings daily. This has supported the transparency benefit of ETFs. However, this requirement concerns some active managers, who may be worried about disclosing their intellectual property and/or opening their fund to “front-running”.
In the US, the Securities and Exchange Commission (SEC) recently gave the green light to new models of semi-transparent ETFs that limit disclosure risks and enable fair value pricing by brokers.
European regulators currently require ETF managers to disclose their portfolio holdings daily, creating a barrier for some firms wanting to launch active ETFs. However, the decision by the SEC to approve active non-transparent ETFs, coupled with the robustness of those ETFs during the recent volatility market, has strengthened the view that European regulators will follow suit; with many experts saying it is inevitable within the next 12-18 months.
#4 It Has Never Been Easier or Less Expensive to Launch ETFs
In the early days of the industry, ETFs were treated as a distinct business line, requiring a significant initial investment and multi-year spend. More recently, firms have realised that ETFs are, at their simplest, a fund wrapper. Supported by an ecosystem of third parties and vendors that has developed around ETF issuers, managers now have a multitude of ways to enter the ETF market, through a range of price points. With a well-thought-out strategy, it can be much easier and cheaper to launch an ETF now than it was even five years ago.
How can Alpha help?
It is clear the ETFs will become an even bigger part of the investment landscape going forward. They have been tried and tested through numerous financial shocks and crises, building up a momentum that is changing the way we invest. All managers should have an ETF strategy for success. Whether it’s entering the ETF market through acquisition, building a platform, through partnerships; or having a clear strategy not to enter, but to compete. Whatever your past view on ETFs, now is the time to test it. We welcome the opportunity to help you do that.
About Alpha’s ETF Practice
Alpha’s ETF practice works with managers looking to enter the ETF market. We help determine the most appropriate ETF market entry strategy and provide the industry expertise and resource needed to build robust ETF platforms and market competitive ETF product. Our team has supported many of the new market entrants in recent years.