Concentrated active ETFs will struggle to succeed in Europe

Active ETF market at ‘crossroads’, says Morningstar’s Calay

Lauren Gibbons


The recent launch of ARK's three thematic ETFs in Europe has prompted a “wave of introspection” among asset managers about whether concentrated active ETFs could represent a significant growth opportunity.

In addition, structural barriers introduce another layer of complexity to concentrated active ETF launches across the continent including transparency and capacity issues.

Monika Calay, director, manager research at Morningstar, said the launch from ARK has prompted firms to reassess their strategies and potentially explore the potential of high conviction active ETFs.

“The European active ETF landscape is at a crossroads,” Calay continued. “While ARK's bold entrance in 2024 has turned heads, it remains an outlier in a market where most active ETFs still favour diversification over concentration.

“Asset managers must confront the question of whether concentrated active ETFs are the way forward in Europe.”

ARK Invest Europe unveiled three active ETFs in April. Within the range, the innovation ETF has the fewest holdings with 36 companies while the AI and robotics product has the most with 42, laying in stark contrast to other actively managed equity ETFs currently on the European market.

For example, JP Morgan Asset Management’s popular active equity ETF range – capturing regions as opposed to themes – adopts a more systematic approach, with holdings spanning between 115 and 708 across the range.

A recent Morningstar report highlighted two key barriers that remain for wider adoption of high conviction strategies from active managers on the continent.

Firstly, active managers often want to protect their own unique strategies and since the UCITS structure requires transparency, this may prompt some hesitancy to launch such strategies in an ETF form.

However, the report highlighted transparency is not an inherent structural barrier.

“Either changes in the regulatory framework or simply market participants getting more comfortable with the disclosure requirements could potentially lead to wider adoption of high-conviction strategies with full transparency,” the report said.

Additionally, transparency is not a barrier for some hedge fund managers. White-label issuers have reported growing demand from these managers to replicate their strategies in a UCITS ETF format, without fearing that transparency will compromise their "secret sauce”.

The report also cited capacity issues as another potential hurdle.

“Capacity refers to the fact that ETFs cannot be closed to new investors if the asset base becomes so large that it could endanger the manager's ability to add value through active management.

“On the plus side, though, the share creation and destruction process inherent in the ETF format protects investors from extreme liquidity shocks.”

Alongside navigating potential structural challenges, Calay said European managers are “carefully gauging client sentiment” before venturing into unknown territories.

“The growth of concentrated active ETFs in Europe may mirror the US trajectory, but the pace will likely be tempered by the absence of the same compelling tax advantages that have fuelled the American active ETF boom,” Calay said.

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