ETFs: crowd funding

If you can't beat them, join them. Exchange traded funds are a growing business and more fund managers want in. According to ETFGI, a consultancy, ETFs had $2.8tn in assets at the end of January, up by over $1bn since 2010. Worldwide mutual fund assets, by contrast, were $31tn last September; far larger, but up a mere third since the start of the decade. Although ETFs and mutual funds do a similar job, they are built differently: while the former are priced (and can be traded) throughout the day on an exchange, the latter is more sedate, being priced just once a day. Less than 1 per cent of ETF funds are actively managed, with most of that in bonds. According to Morningstar only 120 exchange traded products (out of over 1500) have an active strategy.

The lack of product has not been for want of effort - active managers have been keen to tap into the growth. The issue has been the pricing of the funds' assets. Passive ETFs are run off publicly available benchmarks with known constituents. Providing live prices is easy. But active fund managers have been reluctant to publish their holdings in real time lest the market copy the strategy. Without this information, accurate live pricing is impossible.

Still, actively managed ETFs (called ETMFs) are starting to emerge. Last week, Australia's Magellan Asset Management listed the country's first equity ETMF. The fund provides prices directly to the exchange based on internal estimates, and publishes its holdings quarterly. There may be more to come: US regulators have approved investors including Eaton Vance and Capital Group to issue ETMFs, although neither has yet done so.

The appeal of ETFs to customers, however, may lie in more than the ease of trading. Last year, as few as one-tenth of active managers outperformed their benchmark. So it is unsurprising that investors might pick cheaper and more rewarding passive ETFs. During 2014, US investors poured 20 times more funds into passive than active strategies (both mutual funds and ETFs), according to Morningstar. In US equities the contrast is more stark: passive funds had inflows of $175bn; active funds lost assets worth $111bn.

Such a bias suggests that simply providing an active ETF will not guarantee a flood of demand. That will not stop many from trying though. Who said that fund managers thrive by trying to stand out from the crowd?

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