ACTIVELY MANAGED EXCHANGE TRADED MUTUAL FUNDS GETTING BEHIND THE RAW NUMBERS

?????????????????????????? The Financial Times recently ran a piece on the continued impressive growth in Active ETF’s.? There are some very note worthy statistics cited in the article.? I’ll review them, and why I believe they are important, but the point of this post is that, while the growth in the wrapper is truly historic, the story behind the raw numbers is equally important.

·????? Flows to active US exchange traded funds have surged past previous records for both monthly and quarterly hauls, helping to drive assets held in the vehicles above $750 billion at the end of March of this year.

·????? Investors pumped $65.6 billion into active ETFs in the three months to the end of March — more than 50 per cent higher than the previous record of $41billion in the fourth quarter of 2023 — as assets under management in the vehicles rose to $758 billion, according to Morningstar data.? The total is still a small number when compared with the overall size of the ETF market, but active flows are said to have been 42% of 2023 total ETF flows.

·????? The $27.2 billion in flows garnered by active ETFs in March soared above previous monthly high-water marks of $20.7 billion, $17.6 billion and $14.7 billion, which were set in February, January and December, respectively.? Clearly, this trend is not going away.

Flows to Active ETFS are good news but raise some critical issues for Asset Managers and Wealth Managers.? For example;

·????? The contest for prominence in the issuer game is over in Capital Market ETFs, like S&P and NASDAQ trackers.? BlackRock, Vanguard, State Street and Schwab have won the war of attrition and pricing is near zero.? This is a market share game now.? Overall, active and passive ETFs pulled in nearly $195 billion in the first quarter, with BlackRock and Vanguard accounting for roughly half of those inflows. State Street, the third-largest ETF issuer in the US, suffered more than $3 billion of outflows, while the fourth-largest, Invesco, garnered almost $22 billion in net new investments, according to Morningstar.? And periods like 2022, when equity and fixed income each had negative years, perhaps created some momentum back to active management overall.

·????? Both Wealth and Asset Managers need to focus on Organic Growth and not just market appreciation.? Constantly rising securities markets, essentially powered by near-zero interest rates and QE, are no longer the norm.? Mutual Funds have generally been in net redemption for a decade.? Constantly rising markets have masked this.? Defined Contribution plans, which do not offer ETFs, have helped avoid a complete rout in traditional funds, but as demographics turn accumulators to annuitants (and creative minds solve the systems and administrative issues surrounding the use of ETFs), this trend will only worsen.

·????? Traditional Asset Managers are sorting through the 3Cs in terms of their mutual fund product offerings and a possible transition to an ETF wrapper; Conversion, Clone or Class.? Some significant Fund companies, like DFA, have elected to “self cannibalize” and convert significant mutual funds to ETFs and “rip the band aid off” in terms of lower fees and profits.? Others are cloning existing traditional funds (and using the prior track records) to gain an entry into Active ETFs.? Finally, the expiration of the Vanguard Share Class patent has not unleashed a torrent of new filings simply because the Passive Game is over (see above) and the SEC has not cleared share classes for Active Funds.? As an aside, I am currently speaking to a firm that has pioneered a “Virtual Pooling” structure that may enable a single pool to accommodate wrappers as diverse as UCITS, ETFs, Mutual Funds and Offshore Funds.? A combination of enlightened regulation and product innovation may soon break the share class logjam.

·????? Some Firms, illustrated notably by last month's acquisition of Amundi’s US business (and its venerable Pioneer Funds) by Victory Capital Management shows a different strategic direction.? In that case (and others like Legg Mason) better to hand over assets (for either cash or a significant stake in the acquirer) to a firm like Victory, which has shown itself to be a capable acquire and integrator, then to invest in a new ETF product line while also bleeding assets.?

·????? There is a risk to relying on upward trending securities markets and not investing in organic growth and product innovation.? At some point, an Asset Manager’s optimal value is not in its franchise, brand or relationships, but how its AUM map to a lager player.? Industry metrics tend to focus on a multiple of EBIT or revenue, or a percentage of AUM.? Multiples expand if alpha generation is constant and consistent, or organic growth is accelerating.? Beyond that, a firm may find its value is maximized only in the hands of a consolidator or a larger player with significant overlap.? Many storied and respected brands have vanished in the past 20 years.

Macro and demographic factors significantly impact the analysis and industry trends.? The 1980’s move away from Defined Benefit to Defined Contribution retirement plans created a need and demand for more publicly traded securities, as assets shifted away from the customary asset/liability matching and into accumulation and return driven investing.?? As the baby boom generation heads into retirement, accumulation of equities is giving way to more income oriented and risk managed methodologies, which suggests more fee compression and a chipping away at AUM for both asset and wealth managers. See last month’s WSJ piece “Pension Funds Are Pulling Hundreds of Billions From Stocks” for a well written description of this trend in the Defined Benefit version of retirement investing.

Indexing vs Capital Allocation is a live discussion impacting the significant shift to Active Management.? Index returns are sometimes compressed into a small slice of an index basket (think the Magnificent 7’s powering of broader index gains) and stock picking and asset allocation may become a more significant driver of future returns, particularly as the era of lower-for-longer rates and QE seems to be at an end.?

Crypto and alternatives help make the conversation even more interesting.? The SEC’s approval of Spot Bitcoin ETF’s as a wrapper has certainly opened some significant flows into products from prior cynics, but in the grand scheme of things, the numbers are a trickle into the ETF bucket.? It is an aggressive wealth manager that recommends an allocation to Crypto large enough to truly move the needle on returns.? And the eternal quest to make investments that command an illiquidity premium more accessible (and liquid) will continue to drive innovation and catalyze complex actively managed ETFs.

ETFs as a structure have long since proven themselves as an accepted wrapper for investors and their intermediaries.? The numbers provide proof of that. Different types and classes of investors may choose a vehicle based on factors such as cost, tax optimization, ease of use, or type of account making the investment.? Separately Managed Accounts are still a significant tool in the delivery mechanisms of Asset Management firms and provide more opportunity for customization and operational alpha to augment investment alpha.? At the end of the day, Asset and Wealth Managers are hired for their competence, innovation and passion for the client experience.? Scaling those core competencies is always going to be a challenge.? Geopolitical concerns, macro economic conditions and demographics may change facets of the mission and the delivery systems.?

But the medium is not the message.? To cite what may be a cliché anecdote, according to Fidelity Investments, the average investor in the?Magellan Fund?actually lost money during Peter Lynch’s tenure.? Wealth Managers who best serve their clients often act as therapists and behavioralists as much as investment professional, and one should not assume that stats speaking to the explosive growth of a product segment or asset class translate equally to the investor class.

For Investment and Wealth Management professionals, attributes such as passion for the business, caring for clients and always seeking innovation and value generation trump structures and vehicles.