A new gateway to active funds management

18-May-2017

By Daniel Paperny

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SMSF investors have always favoured direct investing, making allocations to managed funds unattractive for many. However, in the current low interest rate environment, new avenues to markets are being sought. Daniel Paperny examines the rise of exchange-listed managed funds, known also as active exchange-traded funds, and the impact they may have for SMSFs.

It was only a matter of time before the drive for portfolio diversification and growing demand for more direct access to asset classes, such as international equities, infrastructure and fixed income, prompted the rise of new investment vehicles in the current low interest rate economic environment as SMSF members searched for ways to make their portfolios work harder.

Where exchange-traded funds (ETF) paved the way for individuals seeking a low-cost and more transparent offering, both advisers and investors stood to benefit from an actively managed solution with direct exposure to a variety of asset classes that would cut out the fees typically associated with investing through a platform. This new investment vehicle would marry deep portfolio expertise and research with higher returns for investors, trading at a market price that would be based on the value of the underlying securities.

What are active ETFs?

Known as an exchange-traded or listed managed fund (active ETF), the share price of this unique investment vehicle is maintained close to the net asset value (NAV) of the investment portfolio, which helps protect the price from becoming disconnected from the underlying assets, particularly during a period of volatility and market dislocation. Built like managed funds but traded like equities, an active ETF offers SMSF investors ease of access to the skill set of a professional active manager in one trade without incurring any additional fees. All units are settled via the Australian Securities Exchange (ASX) Clearing House Electronic Subregister System (CHESS). 

Active ETFs sit alongside other established investment vehicles that emerged in the wake of the global financial crisis (GFC), including the mFund Settlement Service (unlisted managed funds), ETFs and listed investment companies (LIC).

ASX head of customer and business development Ian Irvine believes the re-emergence of LICs in the post-GFC years prompted ETF issuers to respond by developing ETF products that focused on an index that tracked fully franked shares.

“There’s a cat and mouse evolution of different product structures that play to the various growing and changing needs of investors,” Irvine says.
“What we now have available through the ASX since the GFC is an array of low-cost investment products for do-it-yourself self-managed super fund trustees and this is what we call our investment supermarket.”

While the ASX’s mFund Settlement Service was introduced in 2014 to provide investors with an easier way to access unlisted managed funds, the active ETF was carved from the need for a solution that actively tracked a basket of investments not necessarily adjusted to an index.

According to Irvine, the success of these various investment vehicles has opened up a wide array of possibilities for fund managers, which now have a range of ways to reach investors directly. “Fund managers are now thinking what suits their business model, cost parameters and operational inhibitors, which now gives them scope to say which structure is most suitable to bring their product to the ASX,” he says. 

While he affirms the ASX’s position as being agnostic when it comes to the different investment vehicles, he acknowledges some may be more suited to different investor styles. 

“What the ASX brings to the equation is that we’ll help investors understand the detail they need surrounding what the various features, benefits and risks are of each of those structures. Our role is to actually make sure that we have a rules environment that allows these products to come to market in a favoured and secure way, meeting all the ASIC (Australian Securities and Investments Commission) requirements and protect end investors’ best interests,” he says.

Novel but not new

Active ETFs are not new to Australian investors, with Aurora Funds Management recognised as having launched the first exchange-traded managed fund – the Aurora Dividend Income Trust – in Australia in November 2005.Using an active ETF means with one trade on the ASX, SMSF investors can buy an active strategy, which typically they could only access via a financial adviser and a platform. The fund itself acts as a market maker, with the full portfolio only disclosed to the market quarterly, with a lag of up to two months.

This protects the intellectual property of active fund managers and prevents replication.

As there can be no assurance that there will be a liquid market for units in the fund, the liquidity associated with active ETFs is one key risk investors need to be aware of.

Currently, there are 13 active ETFs listed on the ASX with a combined value of $976.1 million in funds under management. The available offerings are shown in table 1.

Magellan’s game-changer

The decision by Magellan Asset Management to launch its Global Equities Fund (MGE), an actively managed ETF in March 2015, could prove to be significant in the rise and evolution of the asset class.Reaching over $700 million in less than two years, the fund is now the seventh largest equity exchange-traded product on the ASX and is one of three active ETFs currently listed by the fund manager. However, Magellan head of governance and advisory Craig Wright notes this has been no easy journey. “One thing that stopped a lot of fund managers before us is under the rules … you have to be able to provide the [indicative] NAV daily and then you have to supply the full portfolio weights and names monthly,” Wright says.

“We managed to negotiate a structure with ASIC that was more consistent with what we see globally, particularly with US mutual fund land … we provide an indicative intra-day NAV [which] updates continuously throughout the day and at the end of the quarter we’ll provide the whole portfolio.”

A key consideration for Magellan’s active ETFs suite is the importance of its SMSF trustee constituency. SMSF investors currently comprise over 60 per cent of the register of total unitholders invested in Magellan’s active ETF offerings, the company confirms.

Wright says the opportunity for MGE rested on the belief that there has been a significant under-allocation to global equities, particularly in the SMSF market, stemming from a lack of access. “Financial planners and brokers are our heartland, but we are also thinking of how we can better penetrate the self-directed SMSF market,” he explains.

“It was about having a product that provides minute-by-minute liquidity, more efficient pricing than an LIC and that was the premise [behind] our offering.”

He believes LICs are the key rival to Magellan’s active ETF products, particularly as he asserts there is a dearth of information available about LICs and their holdings.

“We don’t really see ourselves competing against the ETF market. We think there’s a lot of room in investor portfolios for concentrated actively managed equities and then beta-type products like passive index funds,” he says.

“However, there’s definitely not a level playing field from disclosure regimes between ETFs and active ETFs and LICs.”

Education vital for traction

AMP Capital head of SMSF and self-directed wealth Tim Keegan believes education will play an “incredibly important” role in helping active ETFs continue to grow and prosper. Keegan says there is a high level of interest among SMSF investors in gaining understanding of the role active ETFs could play in their portfolios. 

“The top issue that any SMSF trustee is always thinking about is: what should I invest in next and how do I make sure that I have an appropriately diversified portfolio,” he says.

“I think the opportunity here is for asset managers to put a lot of effort into education around active ETFs, which is why we’ve spent time on reaching SMSF investors.”

BetaShares managing director Alex Vynokur says accessibility and convenience are vital in providing active ETF solutions to SMSF investors. Education, Vynokur says, will continue to play a pivotal role in their uptake. “Communicating to and educating SMSF investors about the fact they can actually build a diversified portfolio comprising of lower-cost index solutions as well as actively managed solutions is really a big positive,” he says.

“But the success of any actively managed strategy over the long term is going to come down to their performance track record and how have they done relative to their benchmark, how their peers have performed and how some of the other substitute product solutions have performed.”

Where to from here?

The question on every watchful investor’s lips is: how will the other fund managers and product providers respond? Legg Mason head of Australia Andy Sowerby says it would be remiss of the fund manager to not be looking intently at the active ETF space to further its own product line.

“Active ETFs in Australia are a well-designed product. One of the things that have held it back in other markets has been the need for full transparency [with] disclosure,” Sowerby says.

“We would expect that they will continue to grow reasonably quickly in the marketplace and therefore we’re speaking to our client base about it.”

VanEck Australia managing director Arian Neiron says that because exchange-traded managed funds bear some similarities to traditional ETFs, they will continue to appeal to SMSF investors seeking exposure to a particular asset class that has performed well or those seeking easier access to actively-managed funds.

“But, unless the active strategy has a strong brand and widely regarded portfolio manager at the helm, education will be more challenging than ETFs alone,” Neiron warns.

Wright believes while the constraints around capability may limit some fund managers, active ETFs could become one of the fastest-growing markets over the next 10 years.

“I think one thing that the market overall has fallen foul of is making sure that they’ve got products that people want and that they don’t have a full supermarket that allows investors to access these products and get meaningful FUM from them,” he says.

Irvine believes the growth of active ETFs will directly depend on how they are regulated by ASIC and it will take several years before they become an “entrenched investment opportunity. I’m sure there will be further innovation in this area … it’s always good to push the envelope and strive for positive development as long as it’s done in a measured and safe way and always keeping in mind protecting the end investor,” he says.

“Others will come and they will copy or replicate what’s already being done and they may bring some additional tweaks, twists and turns to how these products operate, but it’s good to see ingenuity and enterprise when it comes to developing different ways for investors to invest.”

Table 1

Source: Various and directly sourced from interviewees (ASX, ETFWatch.com.au, InvestSmart, AMP Capital, Aurora, Magellan, Schroders)

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