Active exchange traded funds (ETFs) are a great Aussie invention for investors as well as being a global leading product. They combine the benefits of active fund management (the ‘active’ part) with the convenience of being traded like a share on the stock market (the ‘ETF’ part) – providing the best of both worlds.

Australia is also one of only two countries (Canada is the other) in the world that allow Active ETFs. It’s a great Aussie export. Like Vegemite.

Some misunderstandings of active ETFs

Much has been written about ETFs. For example, Roger Montgomery wrote in a note to clients “Is this another diversification trap” in a November 2018 piece that “investors who think ETFs offer safety through diversification are no more protected than those who invested in mortgage backed collateralised debt obligations (CDOs) before the global financial crisis.” I know this is meant to refer to the pitfalls of market cap index investing but it fuels the classic confusion out there that ETFs themselves are bad by confusing ETFs with passive investing. Arian Neiron from Van Eck (an ETF provider) wrote in July 2018 that “Active ETFs are not ETFs” because they don’t track an index, don’t publish their holdings and have higher fees than passive index ETFs. This implies that passive index ETFs somehow have the ‘right to be called’ ETFs but active ETFs don’t. By the same logic, that would suggest that a “passive managed fund is not a managed fund” (as the vast majority of managed funds are active funds). Neither is true.

ETFs have real benefits to investors

Neither Montgomery nor Van Eck’s arguments above get to the heart of what an ETF, and specifically an Active ETF is and why they are good for investors. (An acronym of the benefits - to help you remember them - is SALT, just like the taste of Vegemite.

Simple

I’m not sure when last you applied to invest in a managed fund but I’m sure after the first 20 pages of form filling you were left wondering why it’s so hard to invest. Try doing that across multiple managed funds and it’s enough to head to the pub to spend your hard-earned savings. For any ETF, active or passive, you buy and sell it like a share on the ASX. Open a brokerage account once. Trade as many ETFs as you like at the click of a mouse without any more forms. Simple.

Accessible

A typical managed fund has a minimum investment size that can be anywhere between $5 000 and $20 000. ETFs have no minimums and can thus be bought in smaller amounts. Accessible.

Low Cost

Investing in ETFs require the payment of a brokerage fee as with buying or selling an ASX share. These costs often depend on the size of the trade but a trade online that has the lion’s share of the retail trading market in Australia, will cost you about 0.1%. This includes the ASX as your ‘platform’ to settle and report a trade. Those costs are pretty good compared to managed fund platform costs that are between 0.2% - 0.4%. Actual fund manager fees for ETFs are broadly similar to what they are for equivalent strategies in a managed fund and thus ETFs as a product hold no cost advantage over a managed fund when it come to the actual fee charged by the asset manager. Passive ETFs typically have lower fees than active ETFs, much the same way that passive managed funds have lower fees than active managed funds. None-the-less, transacting in ETFs is low cost.

Liquid

One of the most common misunderstandings about ETFs is that they’re only as liquid as the number of ETF units that trade on the ASX. ETFs do trade like shares and the liquidity of a share is indicated by its average daily value traded. Unlike shares, ETF’s hold a basket of securities (such as shares) and the liquidity of the ETF is determined by the liquidity of the underlying basket of securities. The ASX rules only allows liquid securities to be invested in active ETFs and thus the liquidity of an active ETF is many multiples larger than the ‘on-screen’ ASX value traded in the ETF. If all the investors in an ETF wanted to sell out of the ETF, the ETF issuer could simply sell the (liquid) basket of underlying securities in the ETF to return the cash to the investors. Same would be true on buying an ETF – there is more liquidity when buying an ETF than you can ‘see’ on the trading screen. Two identical strategies in the form of an ETF and a managed fund would have identical liquidity. The ETF would have the added ‘liquidity’ benefit to an investor of the ability to buy and sell the ETF (and switch into other ETFs) intraday. This is ‘liquidity’ that is not available in unlisted funds. Liquid.

Transparent

ETFs are bought and sold at net asset value or NAV (less a bid/offer spread much like managed funds). There are no discounts or premiums to consider, which can exist with closed-end funds. ETF prices are quoted ‘live’ on the ASX all day and issuers of active ETFs publish an indicative NAV or iNAV that closely approximates the actual portfolio NAV during the day. You know what price you’re buying or selling at. Unlisted funds by comparison typically offer end of day NAV for subscriptions and redemptions. If you make the decision in the morning to invest, you have no idea what price you will actually buy the fund at until the end of the day. Active ETFs are required to disclose their full portfolio holdings (contrary to the Van Eck piece referred to above). Yes, for some active ETFs, this is only provided quarterly, but it’s still a higher level of disclosure than unlisted managed funds. Transparent.

The rise of active ETFs

The ETF industry in Australia is still small. ASX listed ETF assets under management (AUM) at end December 2018 was $40.41bn, roughly the same size as the LIC market. This is not a bad effort given the ETF market is much younger.

Of that, active ETFs are only ~$3.5bn and are the new kid on the block. By contrast, the Australian retail managed fund industry AUM is ~$600bn, most of which is in active funds.

ETFs therefore make up less than 7% of the managed fund industry in Australia. By contrast, in the US, the ETF industry has $3.5tn of AUM is about 20% of the size of the mutual fund (managed fund) industry.

Given all the benefits of ETFs mentioned above, the penetration of ETFs in Australia is destined to catch up with that of the US. Active ETFs, coming off a low base, will show even stronger growth.

Active ETFs are a great Australia invention and the regulator and exchange should be applauded for showing global leadership in allowing them.

We should embrace active ETFs in Australia. You can love it or hate it, but the reality is it’s a world leading product. Like Vegemite.

* Chris Meyer is Director of Listed Products at Pinnacle Investment Management - which includes global equities manager Antipodes Partners, that recently launched an active global equities ETF. This article is for general information and does not constitute personal financial advice.