European regulators are yet to approve any semi or non-transparent active ETFs
European regulators are yet to approve semi or non-transparent active ETFs © AFP via Getty Images

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Actively managed and cryptocurrency exchange traded funds are top of the wish list for European financial advisers and institutional investors when it comes to ETF launches.

European regulators are yet to approve any semi or non-transparent active ETFs, which unlike traditional ETFs do not disclose their full portfolio to the market on a daily basis.

Although active fund managers are free to launch ETFs utilising the traditional transparent model, very few have amid fears of divulging the “secret sauce” that they hope will deliver outperformance.

The Securities and Exchange Commission, the US regulator, granted approval in 2019 for several semi and non-transparent ETF models, however, potentially opening the floodgates to a wave of active launches

As of September 2020, active ETFs globally had amassed assets of $228bn, more than double that at the end of 2018, according to data provider ETFGI.

Although this represents just 3 per cent of global ETF assets, a survey of 382 financial advisers, institutional investors and fund managers conducted by Brown Brothers Harriman found that active ETFs are now the product type most in demand in Europe.

Column chart of Assets under management ($bn) showing Actively managed exchange traded products

Antonette Kleiser, product manager for ETFs in Europe and Asia at BBH, believed this year may be instrumental in determining whether they get their wish.

“The US and Asia have made inroads in terms of the transparency issue, a key consideration for active managers trying to get into this space, but the regulators in Europe haven’t moved away from the requirement for daily transparency,” Kleiser said.

“Given what’s happening globally it’s certainly on [the regulators’] watchlist. The feedback, certainly from the Central Bank of Ireland, is that they recognise these issues globally and they are open to conversations with asset managers, but it would require a policy change from them.

“I think it’s something they will look at this year in terms of a change of regulation.”

It is understood that the Central Bank, the Irish financial regulator, is actively looking at the issue.

Deborah Fuhr, founder of ETFGI, said some European investors may be hoping that mutual fund providers create ETF versions of their strategies that come with lower fees.

This has often been the case in the US. Dimensional Fund Advisors, for example, unveiled a 27 per cent fee cut when it outlined plans to convert six mutual funds with combined assets of $20bn into ETFs in November.

However, even if semi or non-transparent ETFs are approved in Europe at some point, Fuhr thought they would struggle to build a strong asset base.

Firstly, “most investors that use mutual funds use platforms that don’t offer ETFs as they do not have connectivity to stock exchanges,” she said.

Secondly, “a bigger challenge” is that “as index products, ETFs are sold as solutions or building blocks” to construct broad multi-asset class portfolios, a role less suitable to actively managed funds that will, or at least should, differ markedly from their underlying benchmarks.

Moreover, institutional investors typically want to see a three-year track record and a minimum of about $100m of assets before buying an active fund.

Further, many retail investors own mutual funds through defined contribution pension schemes, where their monthly savings can be used to buy fractional shares of a mutual fund, but no such fractional ownership structure yet exists for ETFs in Europe.

The lack of commission paid by ETFs may also hinder the growth of active products in European countries where the commission model is still dominant, while growing awareness of the inability of most actively managed funds to beat their benchmarks over meaningful periods of time may prove another hurdle.

Line chart of Assets of bitcoin ETPs ($bn) showing Take-off

Perhaps more surprisingly still, the second most in demand ETF strategy among European investors is cryptocurrency funds, with their counterparts in the US and Greater China also craving them.

Kleiser believed this was less unexpected however, given the strong performance of bitcoin and some other cryptocurrencies in the past year.

Bitcoin ETFs saw record inflows of $221m in February, according to TrackInsight, a data provider, taking assets to $4.5bn.

Last month saw the launch of the first bitcoin ETF in North America by Canada’s Purpose Investments, joining a rapidly swelling phalanx of similar exchange traded products in Europe.

Elsewhere, the BBH survey found that most institutional investors in the US and Europe, and an overwhelming majority in Greater China, envisage that ETFs managed along environmental, social and governance (ESG) lines will account for less than a fifth of their ETF holdings in five years’ time.

While this would still be an increase on today’s levels, it is far from the “everything will be ESG” mantra popular in some quarters, driven not only by accelerating ESG launches but also a growing trend for non-ESG ETFs to convert to the in-vogue format.

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