There’s no doubt that exchange-traded funds (ETFs) have changed the investment landscape. Thanks to their lower costs, intra-day tradability and tax efficiency, the fund type has become the go-to for investment managers. But according to one industry group, time may be running out for sponsors to get into the ETF game.
Especially on the active front.
With competition rising, the time for investment managers to start an active ETF strategy is now. There’s a real risk that many will be left out in the cold if they don’t act today. With that, 2022 could be the year of the active ETF and eclipse last year’s record number of launches.
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A Big Year
All in all, more than 445 ETFs launched during 2021, and the vast bulk of them – about 60% – were active ETFs. It’s easy to see why. After conquering the world of passive/index investing, the next logical step was for asset managers to use the fund structure to develop new active strategies. And thanks to recent changes at the SEC, dwindling expense ratios and the overall benefits of ETFs, investors were keen to use the fund type for active strategies.
The best part is 2022 could be even bigger and set more records when it comes to active ETF launches. That’s according to a new report from investment researcher Cerulli Associates.
In their latest report – dubbed U.S. Exchange-Traded Fund Markets 2021, Cerulli Associates lays out the case that more active ETFs are coming to the market in the new year in a big way. According to Cerulli analyst and lead report writer, Daniil Shapiro, 2022 will be a “pivotal year” for ETF launches. In the report, the vast bulk of investment sponsors are looking at launching new active ETFs. And they are doing so via all the various structures available.
More than 70% of ETF issuers polled in the survey are planning or developing transparent active ETFs. These funds disclose their holdings on a daily basis and remain the most popular choice for both sponsors and investors. However, non-transparent funds and semi-transparent structures are also gaining steam with sponsors. Cerulli shows that 50% of polled investment managers are planning/developing non-transparent funds, while 42% are looking at semi-transparent launches. Non-transparent ETFs disclose their holdings only once a quarter like mutual funds, while semi-transparent ETFs use a basket of other assets – cash, bonds, etc. – to mimic net asset values of holdings.
Another huge source of active ETF launches, according to the researcher, are mutual fund conversions to copycat funds.
After several big-named mutual fund houses – like Dimensional Advisor and T. Rowe Price – converted classic mutual funds into ETFs or launched ETF clones of the mutual funds in 2021, the trend was set for other rivals to follow suit. Thanks to lower expense ratios/fee hurdles and tax efficiency, investor interest in these products has been swift.
Another big catalyst according to Cerulli will be the expiration of Vanguard’s patent on ETFs. Thanks to this, Vanguard has been able to call its ETFs a share class of its broader mutual funds. This has led to asset gathering and tax efficiency even for the mutual funds themselves. This patent expires in 2023 and could signal a huge shift in the industry.
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The Time Is Now!
The main point of Cerulli’s study is that sponsors have to act quickly and that 2022 will be the “go time” year for active ETF adoption and launches.
The reason is simply that many managers are going to be left in the dust if they don’t act. Just like with the passive boom, early adopters and sponsors will see all the spoils. One of the reasons why State Street, Vanguard and BlackRock control the bulk of passive index ETF money has to do with their first-mover status into ETFs. They were able to gather assets and size, cut expense ratios, and boost trading volumes – all of which then begets itself again.
Active is in the same boat. We’re just starting to see the beginnings of the movement and sponsors need to get out ahead to win. A first-mover fund in a category or asset class has plenty of potential to be the top-dog ETF. Asset managers that don’t move could be left in the dust.
This is particularly true when factoring in the demand side of things. The report notes that financial advisors may already be ok with the number of active ETFs in several asset categories, including U.S. and international fixed income, alternatives, municipal bond, commodity and sector stock funds. U.S. equity active ETF demand/expected supply is nearly equally matched.
According to analyst Shapiro, “This is the year that ETF issuers or legacy mutual fund managers have to make a decision as to how they are going to participate in this active ETF landscape,2022 is the year that they really have to decide which strategy they are going with.”
A Surge in New Active ETFs
So, what does this all boil down to? We’re going to see a ton of new active ETFs hit the landscape in the upcoming year. The pressure to launch funds is too great. For our portfolios, this could be great news.
Already active ETFs are starting to drive better performance. With the growing number of launches, we will now have more choices with which to grow our portfolios. And that is a good thing. With 2022 being “go time” for active ETFs, investors will be the real winners.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.