Market turbulence spurs demand for fledgling active ETFs
Passive funds still rule industry, but perceptions might be shifting
Rocky markets have been a boon to active managers in exchange-traded funds, an industry long synonymous with the rise of passive investing. ETF managers who handpick stocks and bonds drew a record $27.5 billion in new investor cash last year, while inflows into index-tracking ETFs slowed for the first time since 2013, according to Morningstar. Socalled strategic beta funds, a hybrid between active and passive management, likewise had a banner year, garnering $74 billion.
Although passive funds still dominate the industry, the gains show there is room for active managers in ETFs, especially in volatile markets. That’s good news for ETF issuers specializing in more sophisticated strategies that have struggled to gain ground against low-cost index funds offered by giants like BlackRock Inc. and Vanguard Group.
“The human element of active ETF management is appealing to investors who are getting skittish when markets are volatile,” said Todd Rosenbluth, director of ETF and mutual-fund research at CFRA.
Most of the active gains came from demand for fixed-income ETFs, a fast-growing segment of the industry that gained traction last year as interest rates rose.
JPMorgan’s Ultra-Short Income ETF is a case in point. Launched in May 2017, the actively managed fund took in almost $5 billion last year.
The popularity of active fixedincome ETFs has helped shift investor perceptions of the industry as a purely passive one, Mr. Rosenbluth said.
“The lines have blurred,” he said. “We’re seeing more large active managers enter the active ETF space.”
The rise of active ETFs has been long heralded but much delayed. Active funds account for just 2% of the $3.4 trillion invested in U.S. ETFs. Although passive-ETF flows slowed by 33% last year, they still garnered $282 billion—more than 10 times the cash drawn by active funds.
But the rise of ETFs has also coincided with a decadelong bull market that has left most stock pickers in the dust. Less than one quarter of U.S. active funds beat their index-tracking peers in the past decade, according to Morningstar. Investors fled.
Now the prospect of more turbulent markets has investors reconsidering their commitment to plain-vanilla indexing, Mr. Rosenbluth said. Active ETFs are especially appealing because, while more expensive than passive ETFs, they can be significantly cheaper than actively managed mutual funds, he added.
A wider selection of active ETFs tops the current wish lists of U.S. investors and advisers, according to annual surveys by Brown Brothers Harriman.
In the past year, 73 new active ETFs went on the market, more than any other category, according to a Tuesday report from Morgan Stanley analyst Michael Jabara. Just this week, ARK Invest launched the ARK Fintech Innovation ETF, an actively managed fund that invests in financial technology firms.
The fund has already raised $39 million, according to FactSet.
Active ETFs still face headwinds. Unlike mutual funds, most ETFs disclose their holdings daily. Transparency is anathema to many stock pickers, who don’t want to share their trading strategies with competitors.
“If you’re a mutual-fund warehouse, you’re trying to figure out how to grow your business without giving away your secret sauce,” said Nichole Kramer, an ETF supervisor with Alps Inc.’s intermediary services division.
Longtime active money managers, including Fidelity Investments and T. Rowe Price Group Inc., are also crossing their fingers that 2019 will be the year regulators finally green-light new types of ETFs that don’t disclose their holdings every day.
Approval will open the floodgates to proprietary strategies from managers who have steered clear of ETFs because they don’t want to disclose their trading secrets. Five such proposals are pending before the U.S. Securities and Exchange Commission.
“It seems like the perfect time for active management to prove itself after years of underperforming relative to indexes,” said Ed Baer, an attorney with Ropes & Gray. “I’m hopeful that this is the year.”