Actively managed exchange-traded products (including both ETFs and exchange-traded notes) represent only about 2% of U.S.-listed exchange-traded product assets under management, according to Morningstar Direct, which says these products have an average expense ratio of 0.67%. That’s higher than typical passive ETF ratios, but lower than the cost of traditional active equity mutual funds.
Too Late To The Party?
iShares, Vanguard, State Street, Invesco, Charles Schwab and other leading providers of index-based ETFs have seemingly cornered the market for low-cost passive products. But some industry watchers believe that creates an opening for actively managed products, particularly on the equity side.
“I think there’s still plenty of room for growth because there’s a limited amount of actively managed equity ETFs,” says Grant Engelbart, senior portfolio manager and research director at CLS Investments, which constructs portfolios and manages ETF strategies for the advisor clients of its parent company, Orion Advisor Solutions.
“The likes of T. Rowe, Fidelity, BlackRock, Capital Group, J.P. Morgan and all of the other names involved in the semi-transparent active ETF space have such powerful sales forces and are bringing that to a structure [ETFs] that’s cheaper from a cost and tax perspective, so I think there’s a huge runway for these products,” he adds. “Particularly when you look at the strong U.S. equity market this year and the preliminary capital gains payouts I’ve seen, I think investors will look for opportunities for a more efficient structure, and I think this will provide that for them.”
Regarding asset allocation, many financial advisors use ETFs as cheap beta to fill the core positions in client portfolios and complement that with satellite positions in active equity mutual funds or thematic ETFs to generate alpha. Engelbart offers that active, semi-transparent equity ETFs could be a logical replacement for equity mutual funds in portfolios. “It’s unlikely that super-cheap beta funds will be replaced by actively managed funds,” he says.
Cannibalization
But if people, say, dump a Fidelity equity mutual fund in favor of a similar strategy found in a Fidelity ETF, that’s potentially a case of robbing Abbott to pay Costello. In other words, will asset managers be running to stand still on the asset front if investors dump their mutual funds in favor of cheaper ETFs?
Tim Coyne, new head of ETFs at T. Rowe Price, doesn’t fear that new ETFs will cannibalize the company’s existing mutual fund franchise. “I look at this as being additive to the business, and it’s going to be great for our clients and the firm,” says Coyne, who joined T. Rowe Price in October after spending the past 13 years at SPDR ETFs, where he most recently was global head of capital markets. “It will put us in a position where we can expand upon our product set and potentially reach new clients. There are certain clients who have gravitated more toward the ETF structure, and having ETFs gives us an additional way to enable investors to access T. Rowe Price’s investment capabilities through their product of choice.”
Coyne notes there could be some strategy overlap between existing mutual funds and new ETFs. “We’re looking at both existing strategies and potential new strategies,” he says.
But some ETF participants say cannibalization could be a real threat for asset managers, particularly if they plan to simply repackage existing mutual funds into new ETF wrappers. “There is a risk,” says Shawn McNinch, managing director of investor services at Brown Brothers Harriman, which does ETF-related custody and administration work. “I talk to ETF managers and sponsors, which gives me insights into their strategies. At the macro level, while their initial read might be, ‘Hey, I’ll just clone this product,’ I think when they start peeling back the onion they find more obstacles and challenges if they just want to clone their product and what that might mean for cannibalization. I think the vast majority of asset managers coming out with active, semi-transparent strategies will have different products and [are] not really cloning their existing mutual funds.”