Australia's active ETF industry is on fire. Or is it?
Industry growth looks strong, but it's all concentrated in a small group of funds.
Flows into US active exchange-traded funds hit US$87 billion during 2021, growing by 44% year-on-year and bringing total assets under management in the sector to US$295 billion. A quick peek at the Australian active ETF market suggests a similar dynamic: a record number of product launches and flows, with net inflows growing year-on-year, though looks can be deceiving.
Active ETFs straddle the ETF and active fund universes, offering easy access to a managed investment through a listed access point. As with any investment vehicle, active ETFs have advantages and drawbacks. Despite featuring many of the same benefits as passive ETFs, including liquidity and price transparency, active ETFs will generally come at a premium, with higher expense costs than their passive counterparts, though they may be lower than the equivalent open-end fund. Combining active management with an ETF structure provides an innovative way to access opportunities for index-beating returns.
We examined the growth of active ETFs in our Australian Listed Managed Investment Report, detailing the listed investment company, or LIC, conversions to active ETFs, with managers at funds such as Magellan High Conviction ETF MHH and Monash Absolute Investment Company MA1 adjusting their product structure to solve for persistent discounts to net tangible assets. Additionally, other managers such as those at Hyperion Global Growth Companies ETF HYGG launched active ETFs, giving investors access to their products through both listed and unlisted access points.
The year 2021 saw a record number of active ETF launches on the Australian Securities Exchange with the equity sector accounting for the majority of the increase. Of the 11 active ETFs launched during the year, eight were equity strategies; fund managers such as Janus Henderson, Perpetual, and Loomis Sayles joined the ASX’s ranks, with Janus Henderson Global Sustainable Equity Active ETF FUTR, Perpetual Ethical SRI ETF GIVE, and Loomis Sayles Global Equity Quoted Managed LSGE.
Flows through a different lens
For the 2021 calendar year, the active ETF group saw net flows of $2.25 billion. This represents consecutive years of more than $2 billion net flows, though the rate of change has slowed dramatically, with 2021’s year-on-year growth of 3% significantly lagging the 56% in 2020.
Additionally, looking past the headline numbers reveals some interesting investor preferences as it relates to sectors. While the equity sector dominated the number of product launches and absolute flows, fixed income was the winner for year-on-year growth. The sector saw $773 million net flows, growing by 114% relative to 2020.
Following the record number of product launches, active ETFs continue to account for a larger portion of products listed on the ASX, now comprising 25% of exchange-traded products, up from 15% in 2017. Despite the growing number of strategies available, as a percentage of flows relative to the overall ETF market, active ETFs continue to decline.
The active ETF market peaked at 15% of overall ETF flows in 2018 and has been falling since, with 2021 seeing the sector receive 11% of the total flows. This is in stark contrast to the United States, where active ETFs continue to gain, representing only 4% of the ETF market while accounting for 10% of the overall flows.
Further to the declining share of total flows, the market is concentrated in a few large strategies. The sector is dominated by Magellan, with its Global Active ETF MGOC, Global Equities Currency ETF MHG, Infrastructure Currency Hedged ETF MICH, and High Conviction ETF MHHT accounting for close to 60% of active ETF AUM on the ASX, though names like Hyperion, BetaShares, and Ardea have made gains in recent years with Hyperion Global Growth Companies ETF HYGG, BetaShares Active Australian Hybrids ETF HBRD, and Activex Ardea Real Outcome Bond ETF XARO.
Who were the winners in 2021?
Flows paint a similar picture; a small cohort of strategies accounts for the bulk of 2021’s net flows. Credit and alternatives were favoured, as HBRD and XARO captured the largest portion, though flows into Vanguard Global Value Equity Active ETF VVLU also indicate that investors are conscious of a potential rotation to the value investment style. BetaShare's HBRD dominated proceedings in the fixed-income sector; of the four active ETFs on the ASX, HBRD accounted for 80% of the flows. Ardea also featured; of the eight active ETFs in the alternative sector, 80% of the flows were secured by XARO. Further, both strategies represented a significant portion of the overall active ETF flows, at 27% and 21%, respectively.
Interestingly, not all of these strategies generated above-benchmark returns for the calendar year. Of the group, only HBRD and VVLU beat their category index, while the other three lagged behind, suggesting the crowd isn't fazed by short-term underperformance. Additionally, given Munro Global Growth ETF's MAET and MICH's associated costs, with total cost ratios of 268 basis points and 112 basis points, respectively, Australian investors are prepared to pay; fees do not appear to be a mitigating factor for investment.
While active ETFs experienced a coming-of-age in the US last year, the Australian market saw more of the same: flows concentrated in a small number of established players. Interestingly, while US investors were favoring bitcoin ETFs and Cathie Wood's ARK Innovation ETF ARKK in 2021, Australian investors were looking to diversify into alternatives and credit, as well as protect their portfolios against a possible style rotation. Given the nascent local market, one should expect a continuation of the growth in the active ETF space, though, as with managed funds, the concentration into a few established names may be one trend that's difficult to reverse.