Behind Active ETFs’ Small Victories

The ETF market is predominantly the realm of passive management. About 90% of all ETFs are passively managed, and together, they command 98% of all U.S.-listed ETF assets—more than $3.5 trillion.

This dominance just doesn’t budge, year after year. But in the past 12 months, actively managed ETFs have claimed some small victories.

First, the segment pulled in roughly $24 billion in fresh net asset flows in one year (as of May), according to our data. That may not seem like much compared to the $257 billion-plus passive ETFs attracted, but it represents a 32% growth rate in the asset base tied to active ETFs. That’s nearly five times the percentage growth passive ETFs saw in the same period. Today the 234 actively managed ETFs in the market command north of $77 billion in total assets.

What’s working? Broadly, most of the success in active ETFs has centered in one asset class: fixed income.

Bond markets are known for being inefficient, difficult to access and often illiquid—the perfect playground for good active managers to add value.

About $60 billion sits in active fixed income strategies as of early May, the bulk of all the assets in the segment. Of the 10 largest actively managed ETFs today, nine are fixed income strategies. This is a space where active has done really well.

(Table below plots 12-month asset flows into active ETFs through May 2019.)

Active Funds By Asset Class

More specifically, however, in the past 12 months, the apparent pickup in investor demand for active ETFs can be explained by two trends.

When Active Is The Only Option

The first trend is about access. Some of the most popular active ETFs in the past year are, in many cases, the only ETFs investors have to access some parts of the market.

In other words, these strategies have no real competition in the passive space. We are talking about fixed income ETFs that serve as money market fund proxies.

In 2018, the PIMCO Enhanced Short Maturity Active ETF (MINT) picked up $4.2 billion in net creations. MINT, which aims to deliver higher current income than the average money market mutual fund by investing in a diverse mix of high-quality, ultra-short-term bonds, has $11.8 billion in total assets.

The competing JPMorgan Ultra-Short Income ETF (JPST) pulled in $6 billion in the same period, rising to the No. 2 spot in the ranking of biggest active ETFs, with roughly $7 billion in total assets. The iShares Short Maturity Bond ETF (NEAR) saw $2.5 billion in net inflows in 2018, and today boasts $6.2 billion in total assets.

Flattening Curve

These active money-marketlike ETFs have benefited from massive investor demand in 2018 tied to the flattening of the Treasury yield curve. However, this demand for cashlike active ETFs may not have been about conviction on active management per se, but more about necessity—this is a segment of the fixed income market where passive strategies are hard to find.

“It would be very difficult to manage a money market index—and track it—with paper disappearing every few days,” said FactSet Director of Research Elisabeth Kashner. Active management, in this case, is a solution to a problem, and therefore, it’s found a strong following.

“Virtually all the products in this space are actively managed,” she added. “What you're looking at in this instance is not so much a flight to active management as a flight to cash in the ETF format.”

MINT is today the biggest active ETF. JPST, NEAR and the First Trust Enhanced Short Maturity ETF (FTSM) all follow at the top. These four funds command almost $30 billion.

“In my book, it’s hard to claim that as an outright victory for active management, because if there's no passive alternative in this space, what do you do?” Kashner said.

Other Pockets Of Fixed Income

Outside of cash management tools, issuers have also found good traction in the unconstrained bond ETF space—think ETFs like the SPDR DoubleLine Total Return Tactical ETF (TOTL) and the PIMCO Active Bond ETF (BOND), together commanding about $5.5 billion. Assets have also started flowing increasingly into the muni space.

Here’s a look at the biggest active ETFs and respective flows in the trailing 12 months (May to May):

ETF Giants ($M)

Magic Of BYOA

The second trend driving adoption of actively managed ETF in recent months is one that doesn’t apply only to active ETFs.

It’s what we call the “bring your own assets” phenomenon: big mutual fund managers creating proprietary ETFs, and reallocating in-house client assets to these ETFs or, at least, making sure their ETFs have some kind of bespoke client when they come to market.

BYOA has meant many newcomer ETFs—a lot of them active—become overnight giants with impressive asset bases and liquidity. J.P. Morgan has been known to do that. The firm is one of the biggest buyers of its own ETFs. John Hancock and Goldman Sachs have done that as well, among others.

This type of asset growth is impressive, but again, it speaks little to the success of active management as a solution. It speaks more to the success of the ETF wrapper itself, as mutual fund giants enter the space to meet client demand.

BYOA has meant asset growth for active, and is therefore another victory for the segment, but it hardly suggests active management has found a footing in the ETF space.

Active ETFs still command only 2% of all U.S.-listed ETF assets.

Organic Success Standouts Outside Fixed Income

That said, there have been some organic successes in active ETFs outside of fixed income, and outside of BYOA. Consider, for instance, the First Trust North American Energy Infrastructure Fund (EMLP).

EMLP is the only equity ETF found among the top 10 largest active ETFs. The fund is one of the only strategies to tackle the master limited partnership (MLP) space through active management, focusing on energy infrastructure.

With $2.4 billion in total assets, EMLP is a complex strategy because, unlike its competitors, the fund can’t allocate more than 25% of its portfolio to MLPs per 1940 Act Fund restrictions, according to FactSet. That means EMLP isn’t purely an MLP play, since it taps into a broader universe of securities.

Perhaps its biggest competitive challenge, however, is its price tag—something that weighs on a lot of actively managed ETFs. EMLP costs 0.95% in expense ratio, more than twice the price tag of the competing Global X MLP ETF (MLPA) and more expensive than the Alerian MLP ETF (AMLP).

Still, in the past 12 months, EMLP has delivered stellar performance relative to some of its peers:

Another success story among active names is the lineup of ARK ETFs.

As a firm, small active manager ARK Funds has become known for its ETFs’ strong performance and unique portfolio allocations—ARK funds were among the first to offer investors access to bitcoin, for example.

Focusing on what it calls disruptive innovation, ARK has shown that a hands-on approach to a segment often populated by smaller-cap, "growthy" names can be an interesting choice. And investors have taken notice. The ARK Innovation ETF (ARKK) is a global equity fund that has amassed $1.6 billion in assets. The ARK Web x.0 ETF (ARKW), also global equity, now has $500 million. Today ARK commands nearly $3 billion spread across seven ETFs.

Charts courtesy of StockCharts.com

These are just some examples of actively managed ETFs that are working, finding investor dollars despite often heftier price tags.

If success in this space is hard to come by given the undisputed benefits of passive management, fund issuers continue trying.

The latest move in the effort to push active management forward in the ETF world is nontransparent active ETFs.

Nontransparent: Innovation Or Distraction?

Earlier this year, Precidian Investments finally got regulatory approval for its proposed nontransparent actively managed ETFs. The new structure will function much like an ETF except that its portfolio holdings will not be transparent to investors.

In theory, the idea is to offer investors access to active managers’ secret sauce without exposing them to the risk of front-running. Precidian says this wrapper would also mean lower costs, greater efficiency and a lot of flexibility to active managers themselves.

But is a nontransparent active ETF really going to be a game changer for actively managed ETFs? A look at asset flows over the last several years points only in one direction: out of active and into passive. It’s hard to image anything derailing this trend.

“There's no question the asset management industry is excited about nontransparent active, but to make a case that the generic ETF investor is interested in it, that’s hard,” Kashner said.

“I believe nontransparent active is a solution in search of a problem,” she added. “To put it more definitively, the problem is in the traditional active asset management space, and if they think they're going to solve it by putting the same product in a different wrapper, they haven't convinced me yet that they’ve solved an investor problem.”

Contact Cinthia Murphy at [email protected]