The biggest shift in funds management – is it reversing?

Disagreement? Or just interpretation…

In the dataset of ETPs that have been listed at any time in the last three years, from a total of 447 products, there were:

• 277 ETFs (62%)
• 122 Active ETFs (27.3%)
• 42 Complex ETFs (9.4%)
• 6 Structured Products (1.3%)

One way to look at this is that Active and Complex ETFs now make up more than one third of the market.

However, as Marc Jocum from Global X ETFs also pointed out, Active and Complex products now account for more than one third of listing, but they represent just 20% of AUM and 14% of flows.

So, while the numbers look encouraging based on the number of products, it’s less encouraging when you look at total net flows or AUM.

But in defence of Active ETFs, the last 12 months was the best period for Active and Complex ETFs in the dataset. If we adjust for conversions from unlisted funds Active ETFs and Complex ETFs had net outflows in the first and second 12-month period. However, both categories had significant inflows in the last 12 months, which more-than-offset the previous two years.

The point about conversions is an important one. In previous years, a large percentage of the inflows for Active ETFs came from converting units in either unlisted managed funds, or LICs, into Active ETFs. In particular:

• $10.4 billion from the launch and conversion of three Dimensional funds in November 2023 – ASX: DACE, ASX: DFGH, and ASX: DGCE.
• $1.4 billion from the launch and conversion of two Franklin Templeton funds in April 2024 – ASX: FRAR and ASX: FRGG.
• $3.4 billion from the conversion of units in MGF (an LIC) to MGOC (an Active ETF). 

When adjusted for these large conversions, the flows data for Active and Complex ETFs was not flattering in the first two 12-month periods. But the last 12 months looks decidedly different.

• 116 Active and Complex ETFs saw net inflows, totalling over $7.8 billion
• 42 saw net outflows, totalling over $2.7 billion
• On a net basis, these products achieved just short of $6 billion of net inflows. 

But among all this, there is a single fund that muddies the entire dataset (whether or not you adjust for conversions) – the Magellan Global Fund (ASX: MGOC). If conversions are included, it achieved a total of $3.2 billion of net outflows during the three-year period, or if we adjust for conversions, that number jumps to $6.6 billion.

Excluding conversions, MGOC’s outflows exceeded every other fund that had net outflows, combined, in every single year.

MGOC’s challenges are not representative of the entire active sector. But due to its size, and the scale of its challenges, it’s acted as a drag on all datasets where it’s included. 

My take on the data

The last section was very data heavy, but what does it all mean?

It’s true that low-cost, passive ETFs are dominating the market. Products from the likes of Vanguard, iShares, and Betashares have the highest FUM, and consistently attract the biggest inflows. These products often have fees around 0.1% p.a., and five-year average total returns of 10-15% p.a. That’s a high bar to clear.

But I also think that when you look through the muddiness, there really is a story here about a renaissance in active management. ETPs allow retail investors to access quality active managers without needing enormous sums of money to invest, or needing to add multiple layers of fees and costs via financial intermediaries. For managers who offer a unique product, strong performance, and reasonable fees, this has resulted in better access and more inflows – PGA1, the leading fund for inflows over the last 12 months among active products, almost made the top 10 list overall.

The flip side of this is that underperforming managers, especially those with high fee structures, can’t hold onto assets as well as they used to given the reduction in friction around switching.

This is a good thing for markets and investors – more competition, more choice, better transparency. It’s a more efficient market. 

The Active ETF landscape

Investors have access to a wide enough range of products today to build a complete portfolio using Active and Complex ETFs, should they wish to. In addition to major asset classes like Australian Equities, Global Equities (both hedged and unhedged), Cash, and Fixed Income, a wide range of alternative classes and strategies are available to investors, including:

• Property and infrastructure securities
• Equity income strategies
• ESG and Impact investment
• Growth and Value-tilted strategies
• Geared and long-short equities. 

Within these asset classes and strategies, there are numerous, distinctly different approaches available. Looking at global equities, for example, they include:

• Dimensional Global Core Equity Trust (ASX: DGCE) – rules-based, benchmark-unaware exposure, tilted towards smaller, lower priced, more profitable companies versus a market capitalisation weighted index.
• Plato Global Alpha Fund (ASX: PGA1) – long-short, systematic strategy, aiming to achieve higher returns with lower volatility.
• Macquarie Core Global Equity (ASX: MQEG) – quantitative, benchmark-aware exposure which aims to outperform. 

While the funds have very different fee structures, strategies, and even investment universes, all three use some form of rules-based strategy, eschewing discretionary stock selection. In fact right across the list of active products, there’s a noticeable skew towards more rules-based strategies attracting higher flows and FUM, while funds that rely on manager selections have tended to see more outflows.

What to look for in an Active ETF

Fundamentally, the factors to look out for when choosing an Active ETF are no different to those when considering other actively managed products.

Does the fund’s strategy fit with your investment goals and risk tolerance?

If you have a low risk tolerance, highly geared equities are probably not appropriate. If you’re aiming to grow your capital, an income-focused strategy is probably not appropriate.

Is the fund differentiated from the index?

You cannot achieve outperformance by hugging an index and charging 1% p.a. Active share is necessary for outperformance, but not sufficient.

Are the fees reasonable, and are the incentives of the manager aligned with investors?

Fees are important, but some managers are worth paying – to a point. But it’s important to consider the level of the base fee versus the performance fee – does the structure incentivise outperformance, or asset gathering? Investors should also check that the benchmark is appropriate and look for a high watermark.

Where discretionary stock picking is involved, I prefer a higher performance fee and lower base fee, with appropriate safeguards in place.

Is the investment team well established and consistent?

Where discretionary stock selection is involved, I care more about the decision-maker than the brand. The key decision maker is the most critical, but ideally, the senior people supporting them should also have long tenures. This is less relevant with quantitative and rules-based strategies.

I’ve witnessed too many examples over the years of key investment staff leaving a high performing fund, only for the fund to lose its edge.

Has the manager achieved consistent long-term performance?

Ignore the short-term performance, focus on longer-term performance – the longer, the better. Though the funds have often only existed for a short time in listed form, you can usually see the strategy’s performance in its unlisted form (or sometimes as a LIC) to get a better picture of long-term performance.

If the key decision maker has changed during this period, the performance holds less weight in my view.

Is the fund large enough to remain viable?

Very small funds tend not to survive long term. All funds go through periods of underperformance, and they tend to lose FUM during those periods. If the fund can’t survive several years of underperformance, then you may not have the chance to experience outperformance on the other side.

The Renaissance, or just fluff?

Active ETFs are unlikely to dominate flows anytime soon. But the structure has clearly broadened access to active management and increased competition across the industry. For investors, that’s a net positive.

Given the success of managers like Plato, Macquarie, and Dimensional, I don’t think it’s crazy to speculate that we might see an Active or Complex ETF among the top ETPs for net flows in the years ahead.