"Watch this space": Are we entering the age of the Active ETF?

It's the well-worn argument when it comes to ETFs, that they have "democratised" investing, but it's an argument that's hard to deny. 

There's now more than 450 ETFs on the ASX, which collectively see more than 80,000 transactions a day. The total market capitalisation of those ETFs is currently around $350 billion, with more than $50 billion added in the last year. 

It's dramatic growth in a product that has long been commonplace in the US, but that Australian investors have been slower to take up. 

Passive ETFs account for the vast majority of that value, but active ETFs have also been on the rise in recent years. As ETF demand booms, it's an area of the market Macquarie Asset Management believes is ripe for further innovation, according to its Head of ETFs Blair Hannon.

"If you look at where active was two or three years ago, active was only 2% of the market," Hannon said. "Now we've gone to a point where it's around 8%." 

Macquarie Asset Management believes it could hit 15% within a couple of years as providers and fund managers realise the opportunity. 

"Active managers are catching on," said Hannon. "They're not just using the ETF channel as 'we're just gonna open this up for more investors'. They're saying, 'this is a genuine channel, this is where the growth of the market is, and we need to think about how we're going to play in this space'."

Investors are voting with their feet

According to MAM, investors want two things from an ETF - low fees and a "known outcome", meaning a clear investment objective, such as a benchmark or target return, even if that objective isn't always met. 

But there's opportunity to offer something beyond that, Hannon believes. 

"What we're really trying to seek now is more alpha and more consistent performance. Investors have passive - it's great, it works for them, but how can they have a little bit of alpha as part of that?"

"We want to do that, we want to innovate and we want to bring things that are new to the market."

MAM offers nine active ETFs across Australian and global equities as well as fixed income, under portfolio managers Benjamin Leung, Head of Systematic Investments, and Brett Lewthwaite, CIO and Global Head of Fixed Income. 

Genuinely innovative ETFs are something that active managers have mostly failed to deliver, despite the number now offering listed products. 

"There's about 65 ETF issuers on the ASX - nine are passive and the rest are active," said Hannon. "I think where many have struggled is that they've just listed existing funds. We want to bring products that ETF investors actually want, not just things they've already got access to in a different form."

As investors continue to grow more sophisticated, they're demanding more sophisticated products beyond simple index ETFs or listed equivalents of existing funds, says Leung. That's something active ETFs can offer. 

"We certainly feel that the discourse around ETFs is no longer about accessing products," Leung said. "Investors are looking for stronger and better building blocks and portfolio outcomes, and for that consistency and reliability."

As Head of Systematic Investments, Leung is responsible for applying that systematic approach to a range of active ETFs, including the Macquarie Core Global Equity Active ETF (ASX: MQEG).

And in the same way active ETFs may be best placed to offer those better portfolio outcomes, he believes a systematic approach is best-placed to deliver returns in what has become a uniquely-challenging environment for investors. 

"From our perspective I think we can all agree that it's increasingly difficult to construct good portfolios," said Leung. "It's no longer just about stock selection, there's consideration for correlations, macro headwinds, geopolitical tensions, and a whole host of things that would impact your investment outcomes." 

"That volatility is starting to wear thin on investors."

With the majority of active managers failing to beat their benchmarks in recent years, MAM's systematic approach has outperformed. 

"It's fair to say that the investment environment hasn't been kind to active management in in the last couple of years," Leung said. "But I do believe that ability to adapt and the mindset to evolve and change has delivered better outcomes to our investors."

But he says it's not about specifically replacing either passive or active allocations.

"We don't think about ourselves as passive nor active, we just think about how do we create the best investment outcome for our investors."

It's the same philosophy driving Brett Lewthwaite and MAM's suite of fixed income active ETFs. He says ETFs have, even more so than in equities, opened up accessibility to fixed income products and portfolios, and removed many of the prohibitive hurdles facing investors.

The fastest growing has been the Macquarie Subordinated Debt Active ETF (ASX: MQSD), which is positioned as an alternative to bank hybrids that are being phased out. The other recent addition is the Macquarie Global Yield Maximiser Active ETF (ASX: MQYM), which Lewthwaite says "focuses in that white space between domestic credit and private credit".

Many of MAM's active ETFs offer fee structures that are actually more competitive than the fees charged by the big passive ETF providers. Instead of large management fees, they employ a performance fee model, which Leung says reflects the internal conviction that they can deliver outperformance. 

"If you're not adding value above the benchmark, then you don't really deserve a seat at the table. We're very happy to express that conviction and that alignment in the fee structure."

If ETFs have been one of investing's great democratising tools, increasingly sophisticated investors will continue to vote with their feet. The challenge to MAM and other active ETF providers is consistently delivering high-performing products with low fees, says Lewthwaite. 

"We're really just looking at the space and saying, 'can we create better products than what's out there?' And the answer to that is 'absolutely'. And can we do it at the same, if not better pricing?"

"The potential here is significant. Watch this space."