The landscape of investment vehicles is constantly evolving, and one of the latest trends capturing the attention of both individual and institutional investors are actively-managed Exchange-Traded Funds. Unlike regular Index tracking ETFs, which passively track an index, actively managed ETFs (AMETFs) are actively managed by portfolio managers who make intentional decisions about asset allocation and security selection. This dynamic approach aims to outperform benchmarks and aims to deliver enhanced returns, making AMETFs a compelling option for many investors.
According to our ETFSA research, the total market capitalisation of AMETFs listed on the JSE, at the end of June 2024, amounted to R2.4 billion and this figure is expected to grow.
As with other markets, some of the earlier use cases included strategies which are difficult to index such as parts of the fixed income market. We also expect the favourable exchange control dispensation afforded to South African ETF issuers to drive further AMETF product development linked to offshore markets.
Sygnia recently announced that their Itrix 4th Industrial Revolution ETF and Itrix Solactive Healthcare 150 ETF would undergo a ballot process to be converted to actively managed ETFs. Take a listen to the ETF Investor podcast, hosted by Nerina Visser, where she dives into greater detail of the growing trend of actively managed index-based funds, with guest, Iva Madjarova from Sygnia: Podcast Link: https://etfsa.co.za/information-centre/investor-education/ -> Podcasts
An interesting viewpoint that Nerina explores with Iva in the podcast, is the recent trend of using the less restrictive world of active management to offer quasi ‘index-based’ investments, in a more efficient way – this is a form of tightly constrained active mandates closely aligned to the index. In essence, this highlights the current trend of active management techniques being innovatively applied to manage index-based investments more effectively compared to traditional methods. So, what exactly are these techniques?
What Are Actively Managed ETFs?
For starters let us understand what actively managed ETFs are and how they can be used to manage index-tracking investing more efficiently. Actively managed ETFs are a hybrid investment product that combines the best features of unit trusts and traditional ETFs. They offer the benefits of active management—such as the potential for higher returns—while retaining the advantages of ETFs, including transparency, and intraday trading flexibility.
In an actively managed ETF, a team of skilled fund managers make investment decisions based on aspects such as, market conditions, economic indicators, and their expertise. This hands-on approach contrasts with pure index-tracking (passive) ETFs, which simply replicate the performance of a specific index.
Techniques used in Active Management
There are several active management techniques that can be used to manage index-based strategies or portfolios more efficiently, some of which are listed below:
- Enhanced Indexation: Allows for the flexibility of stock selection within the constraints of an Index-tracking methodology, while still broadly tracking the Index. For example, the ability to limit overconcentration to stocks that cannot be avoided by an Index-tracking methodology, or the ability to increase exposure to stocks that are underrepresented in the Index-tracking methodology, which the active manager believes will outperform or underperform relative to other securities.
- Quantitative Strategies & Risk Management Techniques: This technique allows for active managers to apply their quantitative models and risk management techniques to identify potential opportunities and risks in the market. The models may assess factors such as share price movements, company fundamentals, economic indicators, and market sentiment, in making trading decisions.
- Sector Rotation: Based on economic trends, sector-specific fundamentals, or macroeconomic factors, active managers may tilt towards or away from certain sectors, while maintaining a core exposure to an Index.
Challenges & Considerations
While AMETFs offer several benefits, they are not without risks or challenges. Investors should be mindful of the following considerations:
Higher Fees:
Actively managed ETFs typically have higher fees compared to Index-tracking ETFs. This is because there is typically increased trading expenses, research and management costs, potential performance-based fees as well as the complexities of active strategies, that generally contribute to higher fees, relative to more passive counterparts.
Higher Risk:
A common perception is that from a relative performance perspective, an actively strategy is generally associated with higher risk, which comes with higher volatility. Active strategies typically involve more frequent buying and selling of securities in an attempt to outperform the market or a benchmark index. This increased trading activity can lead to higher portfolio turnover and greater volatility in returns compared to a passive strategy that simply tracks an index. There is also an aspect of timing risk to consider. Active management relies on the skill and timing of the portfolio managers and their ability to make informed decisions that beat the market or index. However, predicting market movements and selecting the right investments consistently is challenging, and there is a risk that the manager’s decisions may not pay off as expected.
It is important to highlight that while active management inherently involves higher potential risks, skilled managers could mitigate some of these risks through effective risk management strategies. Active managers would have the flexibility to apply risk management techniques to reduce the overall volatility of the AMETF. By an ETF being actively managed, it does not necessarily always mean greater risk, it may actually result in lower risk, given the manager’s ability to apply these techniques. Investors should carefully evaluate the risk management methodologies and track record of the ETF manager when considering actively managed ETFs as part of their investment strategy.
The future of AMETFs
As the ETP market continues to evolve in South Africa, actively managed ETFs are expected to play an increasingly prominent role in investment portfolios, alongside actively managed certificates (AMCs). The ability of AMETFs to adapt to shifting market conditions, apply active management techniques, coupled with the benefits of transparency, make them an attractive option for a wide range of investors.
