SiGMA FX: Active EFT’s gain momentum as mutual funds face losses

Global finance is experiencing a shift from traditional mutual funds to the rising dominance of exchange-traded funds (ETFs), particularly active ETFs, which are increasing in popularity as mutual funds report unprecedented losses.

Mutual funds experience withdrawals and losses

Actively managed mutual funds have faced a challenging year, experiencing massive withdrawals globally. In the first half of the year, these funds saw withdrawals amounting to a record US $640 billion. This is a sharp contrast to the inflows of US $943 billion reported in 2021, highlighting the difficult environment for traditional mutual fund investments. In contrast, the active ETF sector, although smaller in size, managed to attract a net inflow of US $51.8 billion during the same period. Despite market losses, aggregate assets in active EFTs increased by 1.2 percent to reach a total of $385 billion.

Growth of active EFTs

The growth of active EFTs, particularly in the United States, can be attributed to several key factors. The introduction of the “EFT rule” by the Securities and Exchange Commission (SEC) in 2019 streamlined the process of launching ETFs, promoting growth in this sector. Additionally, the SEC’s approval of non-transparent and semi-transparent structures allowed active managers to safeguard proprietary strategies from public scrutiny.

Conversions of existing mutual funds into EFTs by firms like Dimensional Fund Advisors and JPMorgan have further boosted the active EFT sector. Tax advantages have also played a role, as EFTs offer certain tax benefits due to their unique structure.

While the success of active EFTs is evident, it is important to note that they may not completely replace mutual funds. Instead, active EFTs are poised for further expansion in the investment landscape. However profitability remains a challenge, with competition pressuring fees, potentially impacting the sustainability of differentiated strategies.

Shift in investment dynamics

This shift from traditional mutual funds to active EFTs represents a nuanced change in investment dynamics. Active EFTs, while still tied to benchmarks, aim to outperform them by actively managing their portfolios. This contrasts with the traditional approach of passive funds, which aim to replicate benchmark performance.

Active EFTs are traded on exchanges, similar to investment trusts, but they maintain an open-ended structure and carefully manage liquidity to minimize discounts or premiums. They also offer lower fees compared to investment trust counterparts, making them an attractive choice for investors.

While Europe has embraced active EFTs to some extent, their full potential is yet to be realized. Institutional investors in Europe are increasingly endorsing them, particularly in ESG and fixed income investing.

New avenue for investors

In conclusion, the rise of active EFTs offers investors a new avenue in an evolving investment landscape. While the balance between active and passive funds continues to evolve, active EFTs are carving out a significant place for themselves, challenging the dominance of traditional mutual funds and investment trusts. However, investors should exercise caution and carefully consider their options in this dynamic investment environment.

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