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Investment managers are launching exchange traded funds that are badged as actively managed but operate more like passive funds that track benchmark indices, according to leading industry figures.
These funds were misleading the market with 88 per cent of wealth managers and institutional investors accusing them of failing to live up to their active label, said a survey by Carne Group, the third party management company.
Few active ETFs operate like traditional stockpicking funds, with many instead merely making small tweaks to their underlying benchmarks, a strategy dubbed as “shy active” by financial services group Morningstar.
“We share concerns about the risk of shy active ETFs which can be problematic for investors because they often operate under the guise of active management while closely hugging a benchmark index,” said Patrick O’Brien, head of business development for Ireland at Carne, which provides governance and regulatory service to asset managers.
“Fund managers need to be sure they are transparent about the strategies they offer,” he added.
Scores of asset managers have launched active exchange traded funds in Europe in recent years as they seek to take advantage of rising demand for such vehicles.
Active funds accounted for a record 39 per cent of net inflows to ETFs in the US in the first quarter, far above their 9.4 per cent market share, according to Morningstar data.
Development has been slower in Europe, but the share of active fund flows has still averaged 8 per cent in the past year, ahead of its 2.7 per cent market share.
This growth of shy active ETFs is partly due to European regulations, which have forced all ETFs to reveal their full portfolio on a daily basis.
This deterred managers from launching ETF versions of their most active mutual funds because of the fear of revealing their best trades, which could then be copied by rivals.
However, since December, both Luxembourg and Ireland — Europe’s largest ETF domiciles — have opened the door to semi-transparent fund structures that allow managers scope to hide their portfolios from rivals.
O’Brien expects these semi-transparent models, which are more likely to be used by genuinely active funds, will be widely adopted as managers will no longer have to “give away their secret sauce” and best trades.
“Investors are still seeing people hugging the index but I think that will change. It’s still very much an embryonic market. It will evolve and mature,” O’Brien said.
Kenneth Lamont, principal of research at Morningstar, said active ETFs formed a “spectrum”, adding that “an actively managed ETF that is benchmark aware is not necessarily wrong”, as long as they are not promising a more active strategy.
However, he warned that “not every investor is aware of what they are paying for. I can understand why there might be some level of confusion”.
James McManus, chief investment officer of Nutmeg, an investment platform largely focused on ETFs, said while he understood the concerns about closet trackers, the funds it invested in were “very clear about their tracking error and targets”.
He added that some low tracking error ETFs had a place in portfolios.
“If you can deliver 1 per cent alpha [outperformance] a year consistently, you are 10 per cent ahead over 10 years, and with compounding even more. Investors have a choice whether they want to favour diversification or take the risk with concentration.”
