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Are these active ETFs worth adding to your portfolio?

Glenn Freeman  |  01 Feb 2017Text size  Decrease  Increase  |  

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With five new Australian active exchange-traded products launched last year and more tipped for 2017, ETF investors have more choice than ever but should exercise caution.

 

The Australian ETF market had another year of rapid growth, expanding to $25.4 billion in 2016, from $21 billion in 2015. While this was not as fast as in the years prior--Australian ETFs expanded by almost 50 per cent between 2012 and 2015--it's still extremely quick, especially when compared to the broader managed funds space.

While ETFs have traditionally been regarded as a way for investors to buy an index, this has given way to also include active ETFs--which are often known as exchange-quoted managed funds (EQMFs).

What's an active ETF?

Active ETFs give more exposure to active management and more regular trading, but tend to cost more. In industry terminology, says Morningstar associate director of passive strategies Alex Prineas, "they have wider bid-ask spreads".

"You're giving up the traditional lower-cost characteristics of ETFs ... with the expectation of something more from the manager in the form of outperformance," he says.

Some of the advantages include less paperwork, with trading conducted through a broker or online trading service such as CommSec or eTrade. They also offer centralised reporting via the ASX.

Magellan was the first manager to launch an active ETF in Australia, with its Magellan Global Equity (ASX: MGE) EQMF rolled out in March 2015.

There are now nine active ETPs available to Australian investors, including five that were launched in 2016. Three of these were launched in collaboration between BetaShares and AMP Capital. Betashares handles the operational aspects of running the products, and AMP Capital provides the active investment decisions.

Schroders launched an ETP version of its real-return capability last year, Schroder Real Return ETF (ASX: GROW), though it has a few minor differences from the unlisted fund version.

Magellan also followed up the success of its flagship global equity launch in 2015 by launching an ETP version of its global infrastructure capability.

Morningstar only provides coverage on two of these: the two Magellan global equity products (currency hedged and unhedged). This is because active ETPs are such new products, with only a very brief performance track record.

 

ETP launches in 2016

ETP launches in 2016 table

Source: Morningstar Direct, Morningstar Manager Research, 31/12/2016.

 

Australia leads in active ETFs

While Australia tends to follow the lead of the much larger markets of the US and UK in most aspects of funds management and investment, active ETFs have taken off considerably faster here than abroad.

Morningstar's chief executive officer, Kunal Kapoor, believes regulations are a big reason for this.

"The problem with active ETFs has been that there's a fear ... that it's going to be very hard to run an active fund if you're going to have to disclose your portfolio in real time, because someone can front-run," he says.

While US funds are required to fully disclose portfolios on a daily basis, there is currently no such requirement in Australia, with only the top-10 underlying assets required to be disclosed.

According to Kapoor, these regulatory challenges "have made it difficult for the launch of new active funds in the US".

However, he says the US is starting to gradually shift, with Davis Advisors expected to launch a series of active ETFs in 2017.

"It seems to me it's a matter of when and not if, and it's likely we'll see more and more managers start to experiment in that area," Kapoor says.

Active ETPs in Australia can cost more than their unlisted counterparts and passive products. For example, Magellan charges the same fee of 1.35 per cent for MGE as its unlisted fund Magellan Global Equities, and K2 charges a steep 2 per cent for the K2 Global Equities Fund (ASX: KII) and the K2 Australian Small Cap Fund (ASX: KSM).

According to Morningstar manager research analyst, Anshula Venkataraman, "it's reasonable to expect active ETPs to charge higher management fees than passive ETFs, but be aware that it may also cost more to buy and sell an active ETP".

She warns that, unlike an unlisted fund, you will have to pay brokerage. And in contrast to passive ETFs, bid/ask spreads for active ETPs are typically higher. For example, bid-ask spreads for the Vanguard MSCI Index International ETF (ASX: VGS) sit around just 20 basis points, while MGE's spread has mostly hovered between 40 and 45 basis points.

"Investors should keep in mind that these spreads have been the average experience to date--spreads could compress as assets and track records expand, but spreads could also widen further in times of acute market stress," says Venkataraman.

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Glenn Freeman is Morningstar's senior editor.

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