There are many criticisms you can level at the investment industry, keepers of our pension funds and stocks and shares Individual Savings Accounts.
For starters, high charges and poor performance. Also, complex share classes that often make investing a nightmare –and of course a lack of communication with investors, without whom they would have no business.
Memo to investment bosses: a bit of TLC – tender loving care – given to customers goes a long way.
But the one bit of mud you cannot fling at them is a lack of investor choice. There are funds galore – literally, thousands of them – meeting all investment tastes and coming in many forms. There are unit trusts and open-ended investment companies – a ‘modern’ unit trust often referred to as an OEIC.
Also, stock market listed investment trusts (many of which have been around since the year dot) and passive exchange-traded funds (also listed) which track the performance of specific stock market indices such as the FTSE 100 in the UK and the S&P 500 in President Trump’s United States.
Yet the investment industry believes we need more choice (really?). Enter a new investment vehicle, the active – as opposed to the passive – exchange-traded fund or to give it its sexier (shorter) label: the active ETF.
A vehicle designed to add a little bit of extra return – so called ‘alpha’ – above that available from the market.
Investment houses are falling over themselves to launch these new kids on the block in the UK.
Companies such as BlackRock, Fidelity International, Invesco and JPMorgan (all US giants) have already launched a barrowful. Others such as Aberdeen (no, not abrdn), Jupiter and Schroders are tentatively dipping – or about to dip – their toes into the water.
Already popular in the United States, active ETFs are gaining traction in Europe and the UK, especially among big institutional investors. Research conducted late last year by Fidelity showed nearly a third of professional investors in Europe are looking to increase their use of active ETFs this year and next – more than any other type of investment vehicle.
So will these new investment funds add fizz to your portfolio? Or is the flurry of new launches more about investment groups not wishing to miss out on a potential gravy train?
ETF or an active ETF – So what’s the difference?
AN ETF is an investment fund, typically comprising a portfolio of shares or bonds (sometimes both). In the UK, their shares are traded on the London Stock Exchange.
Until recently, most ETFs focused on replicating the performance of a targeted stock market index.
These ‘passive’ ETFs proved hugely popular with investors as a result of rock-bottom charges, investment predictability (they track a specific market, albeit slightly underperforming it after charges) and the ease with which they can be bought and sold. In essence, they are shares.
To highlight this low-cost appeal, let’s look at a Vanguard ETF –FTSE Developed Europe ex-UK.
As its name implies, it tracks the performance of the FTSE Developed Europe ex-UK Index.
Interactive Investor includes it among its top 60 ‘super’ funds.
It says the combined impact of the fund’s annual charges (0.12 per cent) and its own dealing fee (0.04 per cent) would shave £16.66 off a one-year investment gain of five per cent on an initial £10,000 investment. So, £10,483.34 instead of £10,500.
By way of contrast, an identical investment in OEIC Janus Henderson European Selected Opportunities would be denuded by charges of £106.09. This is primarily a result of the fund’s higher ongoing charges (1.03 per cent) owing to it being actively rather than passively managed. In other words, run by a living, breathing person rather than a computer.
Yet while Vanguard’s ETF is cheap as chips, it has actually underperformed the Janus fund over the past three and five years. In other words, Janus’s active management has reaped better long-term rewards for investors.
An active ETF is designed to offer investors the best of both worlds – the low charges associated with ETFs and the added value that active management can (not will) bring to the party. So a potential win-win.
Roxane Philibert, ETF associate director at Fidelity, says: ‘Active ETFs can play a pivotal role in retail portfolios by combining the advantages of their structure – easy to trade and cost efficient – with the expertise of global research and top investment managers.’
How active ETFs deliver added return varies. But, by way of example, Fidelity offers three versions of its active ETFs: ‘enhanced core’, which aim to provide investors with a return slightly higher than from a specific stock market index; ‘directional active’, which look to make money from identifying shifts in market trends; and ‘high conviction’, where the managers take big positions in stocks they like in the hope of generating that magical thing called ‘alpha’.
Financial advisers are waking up to the potential of active ETFs.
Dan Caps, investment manager at wealth manager Evelyn Partners, says it has started to include the funds in clients’ portfolios, particularly the ‘enhanced’ versions which the likes of Fidelity and JPMorgan are offering.
He adds: ‘They tend to be competitively priced with fees somewhere between a traditional actively managed fund and an index-tracking fund – while offering the potential for a small amount of [market] outperformance.’
Average annual fees are around the 0.4 per cent mark – higher than most passive ETFs but lower than nearly all actively managed investment funds and trusts.
Laith Khalaf, head of investment analysis at investing platform AJ Bell, is more sceptical. ‘Yes, you don’t get the same egregious drag on performance from charges that you do with an actively managed unit trust,’ he says, ‘but they are more expensive than index-tracking funds. So they will need to sing for their supper in terms of delivering outperformance.’
It’s a view shared by Kenneth Lamont, research analyst at fund scrutineer Morningstar.
He describes active ETFs as ‘old wine dressed in new bottles’ – in other words, they do what actively managed funds have always done, but in a different wrapper.
He says: ‘These funds have thrived in the US because they
are treated kindly from a tax point of view. But here, the current push is more about UK investment companies – the likes of Aberdeen, Jupiter and Schroders – not wanting to miss out on the next big thing imported from the United States.’
His conclusion: ‘The advantages for investors are marginal – lower cost than most existing active funds but still more expensive than passive ETFs.’
Mine? In an industry where investors are relentlessly encouraged to diversify, they’re worth looking at.
All platforms allow you to buy active ETFs. A selection can be found at ajbell.co.uk/market-research/screener/etf
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