“Active ETFs are misleading investors” was one of the repeating headlines in financial media last week. The articles picked up the fact that investors were complaining that the holdings of a lot of active ETFs are very close to the holdings of their benchmarks. Hence from the perspective of those investors the respective ETFs do not look like actively managed portfolios. But are these claims right, or are these investors overlooking something?
Well, on September 24, 2024, I published an article called: “Wednesday Investment Wisdom: What are the differences Between Active and Passive ETFs”. Within this article I defined active ETFs as ETFs which aim to beat their benchmark, which I still believe is the right definition of an active ETF, regardless of the level of activity (active share) or outperformance.
That said, some ETF promoters offer so-called (research) enhanced strategies, while others claim that their ETFs are actively managed. These strategies are in most cases clearly linked to the country/sector weightings and/or constituents of the benchmark which they try to outperform by implementing small deviations of the holdings within the ETF compared to the constituents of the benchmark. This means the portfolios of these ETFs are by nature often positioned neutral with regard to their sector and/or country weightings compared to the benchmark.
Conversely, most active ETFs are claiming that they are benchmark aware but are not constrained to the country or sector weightings nor to the constituents of the respective benchmarks. This means the respective allocations can be a guidance for the portfolio construction of the ETF, but do not limit the choice of constituents for the portfolio manager. This kind of management approach is also the approach of choice for the majority of active managers of mutual funds.
In addition to this, there are some active ETFs available in Europe which claim that they don’t have a benchmark which they are taking into consideration for portfolio construction. These ETFs may state a benchmark which they claim to use only for performance comparison. Most of these ETFs hold a high number of securities in their portfolio, which brings their portfolio by nature close to their benchmarks. Similarly for mutual funds, there are only a few actively managed ETFs which are following a high conviction approach—holding only a very limited number of securities (30 to 40)—from which the portfolio manager is convinced that they will outperform the market. Give their portfolio structure, these ETFs can, without a doubt, be called active ETFs.
A closer look at the assets under management and estimated net flows of actively managed ETFs available for sale in Europe shows that the majority of assets and flows can be found in actively managed ETFs which are using a research enhanced investment strategy. This is not really surprising, as this approach seems to be a natural fit for institutional investors which normally follow a rather conservative approach when it comes to the deviations of their portfolios compared to their benchmarks.
Taking the above into account, I can’t understand the accusations that the label of active ETFs is misleading, since the ETFs (at least in Europe) normally state their management approach and level of activity in their legal documents. As for mutual funds, there are some ETFs available which are not true to label and investors have to do their homework to identify those products. As for all kinds of investments, investors should be aware that investing in collective investment vehicles such as mutual funds or ETFs is quite more complex as they may anticipate. Therefore, every investor has to conduct their own research to understand the investment strategy and benchmark exposure of a given product to find those ETFs which suit their needs best. By the way, the same is true for the sector and country exposure of the underlying index/benchmark of an ETF. Unfortunately for some investors, there are no shortcuts to achieve this.
At LSEG Lipper we do help our customers to find ETFs which meet their expectations, as we offer them the choice of ETFs by management approach (active/passive) and level of activity (index pure/index based/no index) as described in the respective fund prospectuses. In addition, LSEG Lipper also offers an analysis of the latest available holdings of an ETF with regard to the sector/industry and country exposure of the portfolio. Please contact myself or any of my colleagues if you want to learn more about the analysis capacities of LSEG Lipper.
This article is for information purposes only and does not constitute any investment advice.
The views expressed are the views of the author, not necessarily those of Lipper or LSEG.
