Active ETFs may seem contradictory to investors, so ETF providers have a built-in challenge to tackle them.
While still a relatively small segment of the overall ETF market, when considered in the context of funds introduced since 2008, active ETFs have played a larger role, with Strategic Insight finding that their assets comprised 7% of the assets of all ETFs launched in the U.S. during that period. With active ETFs becoming a critical growing segment of the ETF market, they can be significantly leveraged by mutual fund managers if they can overcome some key marketing and operational challenges.
Actively managed ETFs share many of the same investor benefits as their traditionally managed, passive ETF brethren, namely improved tax efficiency, transparency, accessibility and liquidity. Additionally, while ETFs also share similar traits with open-ended mutual funds, ETFs - active and passive alike - can also be traded throughout the day on an exchange.
Unfortunately, along with these investor benefits there are a number of challenges for fund managers trying to launch actively managed ETFs. They can be described as follows:
* Product confusion - As a relatively new product, many investors and financial advisors don't have a full understanding of what actively managed ETFs are, or how they work, leading to marketing and distribution challenges.
* Insufficient operational infrastructure - The operations of actively managed ETFs are significantly different from mutual funds - particularly the built-in creation and redemption mechanism - and most money managers do not currently have the proper technological and operational resources to handle these differences.
* Limited track record of performance - Like '40 Act mutual funds, active ETFs require a three- year performance track record to be eligible for Morningstar ratings, yet most funds were launched relatively recently and have short track records.
* Long SEC approval process- Currently, the SEC review and approval process may take upwards of 12-18 months, or even longer, if the ETF uses derivatives
EFFECIVELY MANAGING A LAUNCH
While there are considerable benefits to active ETFs, fund managers should consider the following to ensure that the challenges that exist don't turn into insurmountable barriers.
1. Be an early adopter
While the lengthy approval process and prospect of limited performance results may scare off some managers from jumping into the active ETF market, early adopters are poised to benefit much more than those that wait for the market to mature.
The asset management industry is one founded on innovation and ingenuity and favors those willing to take calculated risks. The evidence is strong that active ETFs are poised to explode and fund managers will not want to be caught on the sidelines.
2. Go into education overdrive
As a relatively new investment vehicle, ETFs face misconceptions regarding technical aspects of the ETF structure. To encourage continued investment, the industry and the managers themselves need to educate investors on ETFs.
With the transparent nature of ETFs, more fund providers are using content marketing and thought leadership as a way to share best trading practices for using newer ETF offerings. Given the current uncertainty about active ETFs, ETF providers could generate interest for their products by simply outlining how the ETFs work given current market conditions and how advisors can best incorporate the strategies into their portfolios.
3. Find partners to ensure operational efficiency
Many operations teams are discovering the increasingly difficult nature of developing internal skill sets and acquiring adequate technologies to meet the rate at which front-office management teams file and launch ETF products. For example, newer entrants into the ETF space will have to undertake a crash course in the creation and redemption process as well as the order process from Authorized Participants. Moreover, many firms are not prepared for the accounting, basket creation processes and tax reporting associated with ETFs.
Consequently, many mutual fund providers would be best to outsource at least part of their ETF operations to shore up any weaknesses.
While the actively managed ETF space is still in its early stages, active management may represent the next growth phase in the ETF industry.
As market participants become more educated with new and innovative wrappers, active ETFs may well develop to be the gateway for managers seeking to break into the ETF business and eventually rival traditional active mutual funds for market share.
Ross Ellis is a vice president at SEI and leads the Knowledge Partnership at SEI's Investment Manager Services division.