Active ETFs

There is now a dozen “active ETFs” listed on the ASX (list below). What are they, and should you consider them?

As you know, I’m not a big fan of “buy and hold” passive investing through ETFs and index funds, especially funds that match the whole market or the ASX 200. Niche or international ETFs have a place, in my view.

Active ETFs are another thing altogether: they are simply open ended listed investment companies (LICs).

LICs traditionally have a certain number of shares on issue, which means that anyone wanting to buy has to get someone to sell, and vice versa. That means the price is subject to supply and demand and can trade at a premium or discount to the net asset value (NAV).

For example, Australian Foundation has 1.18 billion issued shares, a market cap of $7 billion, but net assets of $6.8 billion, which means it’s trading at premium of 3%. That’s caused simply by the forces of demand and supply: there is limited supply and slightly excess demand for AFI shares.

Anyone buying AFI is betting that the premium won’t disappear. Likewise buying at discount (for example Thorney Opportunities at a 4% discount) is hoping to get a whiplash effect if the stock is re-rated at the same time as growing net assets through good performance.

An active ETF does not have a fixed number of shares on issue. If someone puts in an order to buy shares, more are issued and the fund manager has to buy more assets with the money. If shares are sold, the number on issue has to be reduced and the fund manager has to sell assets.

The result of that is that active ETFs trade at, or near enough to, net asset value at all times.

In other words, they behave just like an ETFs, except that the money is actively managed, not passive.

Are you better off with an active ETF than an LIC? Probably, because discounts and premiums are a pain the neck, but there might a downside.

I think we don’t know what will happen in the event of a run (lots of people trying to sell at once, usually during a stockmarket crash).

The price of an LIC would collapse but the fund manager wouldn’t have to sell assets. You could ride it out if you wanted, and most investors would. Eventually the price would recover along with the underlying assets – which the fund would still be holding.

But in a run on active ETF, the manager would have to sell assets as the number of shares on issue reduced. Would the average NTA of remaining shareholders fall in that event? I don’t know (BetaShares says no).

As an Australian asset class, active ETFs are only two years old so the managers and investors have not had to deal with a crash, or even a major correction.

As with types of managed funds, when one eventually happens, the wheat will get sorted from the chaff.

Here’s the list of the dozen (so far) unsorted active ETFs on the ASX, courtesy of BetaShares:

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