In April 2008, I was thrilled to be part of the launch of the industry’s first active ETFs. Invesco’s quant group (IQS) created an ETF in conjunction with Invesco PowerShares that was managed actively versus the Russell 200 Mega Cap index (ticker PRA). We were very excited about the prospects of managing an Active ETF given the explosion in the use of ETFs generally. Unfortunately, the Great Financial Crisis was wreaking havoc on markets at that time and PRA never really took off.
Fast forward 10 years and the market for Active ETFs has certainly grown, but it still represents an extremely small segment of the ETF market. According to an article by Lara Crigger, ETF.com, Active ETFs (225 funds) represent only 2% of ETF AUM ($59 billion in total). Fixed income active ETFs are the most common (81) and the largest, as 8 of the top 10 active ETFs are fixed-income related. It shouldn’t be surprising to anyone that fixed income active ETFs dominate the universe of active strategies given how difficult it is to “index” the bond market. Furthermore, there have been 59 active funds launched in the last year, representing a 27% increase in the number of active ETFs.
Why such little exposure? Could it be the fact that active ETF performance has been spotty at best? According to ETF.com, only 31 of 166 active ETFs with track records greater than 1-year outperformed. Within the fixed income universe, only 16 of 81 funds have track records longer than 5 years, and performance has been weak on a relative basis. That means that only 18.7% of funds outperformed in 2017. That actually seems worse than the percentage of active products in institutional separate accounts that have beaten their passive benchmark.
Fees for active ETFs are also an issue, as active fixed income ETFs (as an example) have an average fee of 0.53%, which is considerably greater than what a fixed income manager running a separate account would charge and certainly greater than a “passive” offering in the space. Now, to be fair, active ETF fees are certainly lower than those offered by mutual funds.
Finally, active alpha is not achieved overnight. The forecasted or expected annual excess return is built up over the course of the year. Active ETFs should not be trading vehicles. These products offer smaller investors the opportunity to participate in an asset class or style category that they might not have been able to given the size of their allocation, but they also need to have patience when investing so that the excess return can be realized.