Active exchange-traded funds (ETF) are all the rage. One of the latest, a bond fund – the Pimco Sterling Short Maturity Source ETF – listed on the London Stock Exchange this week. But what are active ETFs, and should you invest in them?
This is one of the most confusing areas of the market to understand, largely due to a lack of standard definitions. So here’s our take. Most ETFs track indices of various kinds. Capitalisation-weighting, where each firm’s market size determines the size of the benchmark’s holdings, is still the most common method. At the other end of the scale, some form of investment strategy (such as ‘value investing’) can be embedded in the index. Invesco Powershares’ RAFI ETFs and db x-trackers’ optimum yield commodity ETF are examples of funds following strategy indices. At heart, all these ETFs are ‘passive’, in that they follow indices with transparent, predictable rules.
Active ETFs, on the other hand, offer a bet on someone’s fund management skills in an ETF format. The Pimco fund has no index benchmark to track; its stated objective is to generate yield for investors, while preserving capital and offering liquidity. The ETF also has a named fund manager – Mike Amey of Pimco – whose track record you can check.
Why combine active fund management and ETFs in this way? Basically, low-cost ETFs have thrown a bombshell into the cosy world of high-fee funds, with swathes of money switching from traditional managed funds into passive trackers. So many active fund managers – such as Pimco – are seeking to ‘ETF-ise’ their fund ranges.
Interestingly, other active fund managers – Schroders and JP Morgan, for example – have made different moves, introducing low-cost active funds without seeking to add the intraday tradeability that ETFs promise. And here’s the catch. Since an active ETF reports its manager’s activity with a day’s lag, it’s tricky for the fund’s market makers to keep bid-offer spreads tight (since they don’t know exactly what’s in the fund at any given time). That means you risk paying more when buying and selling the ETF than you ought to. In time, active ETFs may well come with the option for retail investors to trade in and out at net asset value, rather than incurring dealing spreads. When they do, the funds may be worth a look. But until then, we’d steer clear.
• Paul Amery edits
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