Ac­tive ETFs can com­pete in many re­spects with unit trusts, writes Pe­dro van Gaalen

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Ac­tive ETFs can com­pete in many re­spects with unit trusts

As the global ex­change-traded fund (ETF) mar­ket has ma­tured, prod­ucts have evolved, with ac­tive ETFs emerg­ing as a small but in­creas­ing seg­ment.

Ac­cord­ing to in­de­pen­dent re­search group ETFGI, global de­mand for th­ese in­vest­ments is on the rise, with 2017 in­flows into ac­tive ETFs and prod­ucts listed glob­ally in­creas­ing by 57.3% to reach $75.2bn in to­tal as­sets un­der man­age­ment at the end of De­cem­ber.

While the SA fi­nan­cial ser­vices sec­tor has been slow to track this global trend, the sta­tus quo is about to change. Ge­off Cook, ex­ec­u­tive di­rec­tor and co-founder of ZAR X, states that one of the big­gest mis­un­der­stand­ings among in­vestors is that an ETF has to be an in­dex tracker. “An ETF can con­sist of any port­fo­lio of as­sets, which is why we are in the process of list­ing a dy­namic ETF that has a man­aged port­fo­lio be­hind it.”

Cook ex­plains that an ac­tive ETF is sim­i­lar to a unit trust in terms of its struc­ture and man­date. It is the process of in­vest­ing that dif­fers. “By ef­fec­tively list­ing a unit trust struc­ture on an ex­change with a trans­par­ent man­date, and op­er­at­ing it as a dy­nam­i­cally man­aged fund, you cre­ate cost and op­er­a­tional ef­fi­cien­cies and boost liq­uid­ity, which is an at­trac­tive value propo­si­tion for in­vestors.”

Ac­tive ETFs of­fer all the ad­van­tages of unit trusts, but with lower bar­ri­ers to en­try in terms of cost and ad­min­is­tra­tive re­quire­ments. In­vestors also ben­e­fit from greater trad­ing flex­i­bil­ity and trans­parency of un­der­ly­ing hold­ings. Th­ese ben­e­fits spurred the growth in the global ac­tive ETF mar­ket.

While fees for ac­tive man­age­ment would gen­er­ally ex­ceed those of pas­sive ETFs, the po­ten­tial ex­ists for is­suers to out­per­form bench­mark re­turns from cap-weighted in­dexes as fund man­agers can change al­lo­ca­tions, per­form mar­ket-time trades or de­vi­ate from the in­dex as they see fit to take ad­van­tage of mar­ket moves, which could off­set the dif­fer­ence in fees.

Ac­tive ETFs would have sim­i­lar re­port­ing re­quire­ments as other col­lec­tive in­vest­ment schemes, which en­sures good gov­er­nance and reg­u­la­tory com­pli­ance, adds Cook.

Th­ese ca­pa­bil­i­ties have also be­come more com­pelling to fund man­agers since the USChina trade war has led to a de­cline in mar­kets, with both the S&P 500 and the Nas­daq 100 shed­ding sig­nif­i­cant value this year. Amid the rise in global ten­sions, in­vestors are un­der­stand­ably look­ing for ways to counter the dip.

While ad­di­tional con­cerns have been raised re­gard­ing the tax ef­fi­ciency of ac­tive ETFs due to higher trad­ing vol­umes, pro­po­nents are par­tic­u­larly bullish about the fu­ture prospects of this in­vest­ment in­stru­ment. In fact, nu­mer­ous claims have been made that ac­tive ETFs will usurp tra­di­tional mu­tual funds within the next 15 years.

While it’s a provoca­tive stance, CFA char­ter holder and di­rec­tor at et­fSA.co.za Ne­rina Visser doesn’t be­lieve that ac­tive ETFs will be the death knell for unit trusts.

“The es­tab­lished in­vest­ment dis­tri­bu­tion model, par­tic­u­larly in SA, where unit trusts dom­i­nate, won’t change any time soon. How­ever, the in­tro­duc­tion of an ac­tive ETF into the lo­cal mar­ket would def­i­nitely sig­nify a shift in trend.”

Visser be­lieves the ac­tive ETF model makes sense be­cause the elec­tronic share reg­is­ter re­moves much of the bur­den­some back-of­fice ad­min­is­tra­tive re­quire­ments in­her­ent in unit trusts. “In ad­di­tion, ETFs of­fer the abil­ity to trade ex­ist­ing units in the sec­ondary mar­ket, which is a ben­e­fit that unit trust is­suers don’t en­joy. The fric­tional trans­ac­tion cost as­so­ci­ated with cre­ation and re­demp­tion of units in unit trusts is an oner­ous and in­ef­fi­cient process.

“How­ever, if you listed that unit trust on an ex­change, this un­der­ly­ing fric­tional cost would fall away, which would of­fer ben­e­fits in terms of im­proved cost ef­fi­ciency and en­hanced liq­uid­ity that could de­liver more ro­bust re­turns.”

Visser adds that a re­duc­tion in ad­min­is­tra­tive re­quire­ments and costs would lower bar­ri­ers to en­try, help­ing to drive broader in­clu­sion among re­tail in­vestors. “A case can cer­tainly be made for ac­tively man­aged listed unit trusts as the next evo­lu­tion of this en­trenched in­vest­ment prod­uct.”

Among those who re­main scep­ti­cal of in­dus­try claims that ac­tive ETFs will re­place tra­di­tional unit trusts, many cite the im­pli­ca­tions of trans­parency as a pri­mary rea­son why as­set man­agers, par­tic­u­larly eq­uity man­agers, would not im­ple­ment their in­vest­ment strate­gies via ETF plat­forms.

While non­trans­par­ent ac­tive ETFs would pro­tect their in­vest­ment strate­gies, Visser be­lieves reg­u­la­tors like the Fi­nan­cial Ser­vices Con­duct Author­ity are loath to change the strong value propo­si­tion that has been built around ETFs as in­dex-track­ing in­vest­ments, as this could con­fuse in­vestors.

Ex­pect greater va­ri­ety and in­no­va­tion from in­dex providers, in­clud­ing fac­tor­based in­dexes and fixed­in­come ETFs.

Ge­off Cook … op­er­a­tional ef­fi­cien­cies

Ne­rina Visser … no change due soon

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