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Off the Record episode 11

The rise of Active ETFs

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Jason Xavier, Head of EMEA ETF Capital Markets, Franklin Templeton and Beverly Chandler, managing editor, ETF Express discuss the rise of active ETFs. What are they and how can they work in an investor’s portfolio? 

This episode of Off the Record is created in partnership with Franklin Templeton.

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Transcipt

Beverly Chandler

Hello, my name is Beverly Chandler and I welcome you to this outing of Off the Record, the podcast about all things ETF brought to you by ETF Express in partnership with Franklin Templeton. All views expressed in this podcast are the speakers’ own and we hope suitably controversial. I’m very pleased to bring you Jason Xavier, head of EMEA ETF capital markets for Franklin Templeton, who is here to discuss the hottest type of ETFs at the moment, active ETFs. Jason, our previous conversations have explained what an ETF is, so let’s open with a reminder of that and then can you tell me what is an active ETF?

Jason Xavier

Well, thanks for having me again, Beverly. It was a great discussion last time, we spoke about defining what ETFs are and the different management styles. So let’s remind everyone what an ETF is. An ETF is an exchange traded fund and it’s important to just understand that it is really just a fund vehicle. It’s a vehicle that can bring you different strategies, different investment styles, and you can get all the benefits that you get from exchange trading funds, being daily transparency of holdings; liquidity; intraday liquidity, ability to trade whenever you want in the trading day; and traditionally ETFs have been very low cost. So the the overall expenses of an ETF and running an ETF has been minimised and as a result that saving has been brought to investors. But what is an active ETF? Well, an active ETF is no different to an active mutual fund, apart from the fact it has all those benefits I just described. So what’s important is just to realise that an ETF is just the wrapper and it’s a delivery vehicle, but it’s giving you the exposure to active strategies. So active strategies that are run by a mutual fund are exactly the same as those that are run by an ETF. And what is active? Active is effectively a portfolio manager has the ability to make investment decisions at his discretion to buy or sell securities, whether they are, whether he believes they are to be undervalued or overvalued, and as a result he can adjust his portfolio as and when he suits. And he’s not looking to track an index, but rather outperform an index or a benchmark.

Beverly Chandler

I thought ETFs were supposed to be passive, so how can an ETF be active?

Jason Xavier

Exactly the same way that a mutual fund can give you an index strategy, which is effectively passive, as well as an active strategy. So again, it’s just a fund vehicle. The ETF is a delivery mechanism, a piece of technology if you like, that gives you exposure to the underlying strategy. Now, ETFs have historically and traditionally been associated with passive index products ok? And that’s the first ETFs that were launched were really indexed passive and that’s how ETFs, you know, effectively grew and became very popular in the industry. So as the popularity of just passive investing grew ETFs grew as well, and the second iterative of that was effectively to take strategies that were still index based but not market cap index based, but alternatively weighted and we we discussed this in the in the last episode. That was the second iteration. The third iteration if you like, is now saying well hang on all the benefits of this ETF vehicle, all the benefits of the wrapper, we want to utilise those in active form so we want to take our active strategies and put those into the ETF wrapper. And for all the benefits that we’ve discussed, deliver those to to investors so they can utilise.

Beverly Chandler

So is it fair to say that an active ETF may not be based on a well-known index?

Jason Xavier

Yeah, that’s correct. So an active strategy is effectively a strategy where a portfolio manager has the full discretion to buy or sell whatever the underlines are, be it stocks or bonds to his discretion. If he sees a stock that’s got some value, he can buy that stock. If he thinks there’s stocks that are overvalued, he can sell that stock. So he will have a benchmark, he will have an index or a benchmark that he’s benchmarked against and his objective is to outperform that benchmark. And the key difference here is he’s not looking to match the index. So traditional passive smart beta products are index based so as per your question, no there’s they’re not attached or they’re not matching or they’re not trying to give you the index return. They’re trying to look to outperform an index that could be used as a benchmark for that outperformance.

Beverly Chandler

Why would you use an ETF to invest in an active manner?

Jason Xavier

Again, it’s the key benefits that the ETF wrapper gives you. So if you think about those three three key benefits and and the two that we’ll focus on is really that daily transparency of holdings and that liquidity that you get, that intraday liquidity, the ability to transact in a fund holding. Now traditionally that has only been utilised in the passive or smart beta space, but now a lot of investors are realising, and especially post pandemic, a lot of investors are realising that having that freedom to make those decisions; having the transparency of holdings; having that intelligence; having the ability to transact if markets are volatile; that should be applied not just to passive management, that should equally be applied to active management. And where there’s a strategy that can be invested in in an active strategy that can be wrapped into an ETF, absolutely, why not give those benefits to investors to utilise?

Beverly Chandler

And what would an active ETF bring to a sort of a normal average investor’s portfolio?

Jason Xavier

Well, again, it’s it’s just a vehicle. So it’s another delivery mechanism. So you will have investors that will utilise different wrappers to get exposure and they can have an active strategy in a traditional mutual fund, but they may also say well look I need to have some form of liquidity sleeve, you know. And this is another real benefit of the ETF, having that liquidity sleeve and that ability to change your portfolio depending on what’s happening and depending on your risk and depending on what’s going on in the market and extra volatility, et cetera, et cetera, having a percentage of your holding in an exchange traded funds gives you that freedom to transact when you want to transact and that’s super powerful. Another big step change for that we’re seeing is the fact that, we’ve spoken about this before, the fixed income space. You know, we’re seeing a lot of growth within the fixed income space and we’re seeing in particular a lot of the growth within the fixed income active ETF space. That market structure, I’ve said it before, that market structure had historically has been a bilateral peer-to-peer market structure. The exchange traded fund has taken that market structure and successfully put it onto a centralised exchange. So you can now buy and sell bonds and bond ETFs with prices that you can see on an exchange. You get that price discovery. Because of that price discovery, it’s a natural next step to bring that price discovery into the active space and the active fixed income space in particular.

Beverly Chandler

So I think that would be my next question is, what investment trends can be represented in an active ETF?

Jason Xavier

Well, all active strategies can be wrapped into an ETF. It really comes down to the transparency of those strategies. So we will find a lot of traditional active strategies could easily be put into an ETF, but you may find that there will be some strategies that won’t suit an ETF and that could be could be intraday strategies; they could be hedge fund type strategies where there’s a secret sauce if you like, a hedge fund portfolio manager’s not gonna want to give away his secret sauce so he’s not going to give you the the transparency holdings every day. But a lot of other traditional strategies and in particular fixed income strategies, you can get that transparency. To replicate a lot of fixed income strategies is difficult. There’s lots of different tenors for a particular bond, different issuers, etcetera, etcetera. So it’s very hard to really figure out what the strategies are. And as a result, we’re going to see a lot more fixed income fall into the ETF wrapper.

Beverly Chandler

And other types of active ETFs, will you find them in equities?

Jason Xavier

In the US, we certainly we’re going to see more and more equity strategies. There is a benefit to utilising the ETF from a tax perspective in the US. In Europe, we don’t have the same tax benefit, so we will see as a result of the tail wind. You know, I grew up in the 80s and everything that went on in the US eventually came over to Europe. And so as we see more and more growth of active ETFs in general, equities, fixed income across the pond, it is only a matter of time before we see more of that over here. But I think within Europe as we sit here now, we’re seeing real interest in active fixed income and that’s that’s that’s really comes down to that market structure piece that I discussed earlier.

Beverly Chandler

OK, thank you so much. I was gonna ask you more about the outlook, but I think you’ve covered it really with your fixed income summary, or is there anything else you’d like to add?

Jason Xavier

No, I think I just reiterate that I really think we really see more momentum behind active, particularly in the fixed income space in Europe.

Beverly Chandler

OK, brilliant. Thank you so much for your time today, Jason. And also to you for listening. Remember to subscribe and leave a review and feel free to contact us at podcast@chandlerpublishing.com. This has been an Off the Record podcast from ETF Express brought to you in partnership with Franklin Templeton.

Outro

Off the Record is brought to you by ETF Express. Production by Imogen Rostron and Lisa Hines and music by Otto Balfour. Thank you to our guests on this episode of Off the Record from ETF Express and to you for listening. We look forward to you joining us next time.

Important Information

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The views expressed herein are those of BlueCove and Harbor Funds Distributors, investment professionals at the time the comments were made. These views are subject to change at any time based upon market or other conditions, and the author/s disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions are based on many factors, may not be relied upon as an indication of trading intent. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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