Economics & Markets

Active ETFs – the basics

By Paul Gambale
Product Director Sydney, Australia

Active ETFs – the basics

An Active ETF is, most simply, a managed fund that is traded on a stock exchange such as the ASX. They are built like managed funds, but trade like shares, meaning that pricing is transparent and they can be bought and sold during any trading day just like ordinary shares.

Active ETFs share many similarities with Exchange Traded Funds (ETFs) but have one key difference: ETFs are “passively” managed and aim to track a particular benchmark or index, whereas Active ETFs are “actively” managed by fund managers with the aim of outperforming a relevant benchmark.

The global market

Exchange Traded Products (ETPs), which include ETFs and other exchange tradeable funds, are one of the fastest growing categories of investment products in the world, with over US$4.4 trillion in total flows as at September 20171. A key reason for their popularity is that they exhibit all the advantages of stocks, such as being easy to trade and liquidity, coupled with the benefits of managed funds, such as diversification.

The Australian experience

The Australian ETP industry, while comparatively small on a global scale, continues to grow strongly and has reached $32.0b2, up from $24.1b3 a year ago. As the chart below shows, the total market capitalisation of all ETP assets has grown from around $5 billion in May 2012 to over $29 billion in September 2017.

Australian ETP Market Cap: July 2004 - Sep 2017 (A$m)3

This growth is expected to continue as Australian investor awareness of ETPs increases and as continued product innovation takes place. Active ETFs are at the forefront of this innovation.

How they work

Like ETFs, Active ETFs are open-ended. This means that, unlike a typical company that lists its shares on the market (including LICs), should investor demand exceed supply, the Active ETF has the ability to simply create more units to meet the demand. Similarly, units can also be cancelled should supply exceed demand.

Active ETFs differ from ETFs, however, in that the fund itself acts as market maker, rather than relying on third party market makers. This means that each Active ETF, rather than third parties, will set bids/offers for investors on market during the trading day.

Third party market makers facilitate pricing and trading on the market for ETFs because ETFs, being index tracking funds, disclose their full portfolio on a daily basis. As such, third party market makers can accurately calculate the true value of the ETF (or net asset value (NAV)) and set bids/offers accordingly. For active fund managers, the composition of their portfolio is their key intellectual property and can’t be continuously revealed to the market; otherwise other parties could replicate their portfolios. Hence, the Active ETF itself acts as market maker, with the full portfolio only disclosed to the market quarterly, with a lag of up to two months. This protects active fund managers and the fund’s unitholders from conduct such as “front-running” and prevents replication.

As self-market maker, Active ETFs provide available bids/offers on market that reflect the fund’s view of “fair value”, as referenced by the indicative net asset value (iNAV), market conditions and the supply and demand for units during the trading day. At the end of each trading day, the fund will then issue or cancel units according to its net position in units bought or sold on the ASX on that day, and any gains or losses from the market making process will accrue to the fund.

For investors looking to trade, the fund acting as market maker will be available on the other side of the trade willing to buy/sell units. This is different from shares in listed companies and LICs, which are traded between Investor A and Investor B only. With an Active ETF, units can be traded between Investor A and B, or in cases when there is no Investor B, the fund as market maker can be expected to be “on screen” to buy/sell directly to Investor A.

How they are bought and sold

Transacting to buy or sell units in an Active ETF is done through any full service or online broker, just like buying or selling a share or an ETF. As always investors should remember to read the Product Disclosure Statement (PDS) of each Active ETF prior to investing.

Find out more about AMP Capital's Active ETFs - Learn more here.

Sources:

1 BlackRock ‘ETP Landscape Desk’, September 30, 2017

2 ASX Investment Product Report September 2017

3 ASX Investment Product Report September 2016

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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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