In the first 10 months of 2024, active ETFs saw inflows of $225 billion, while $582 billion flowed into index-tracking ETFs, according to Morningstar. Appearing in Europe really only a few years ago, active ETFs are rapidly gaining favor with European investors. Fidelity International analysts believe that the European active ETF market could expand to $800bn in assets under management by 2030. Luxembourg is betting on the success of this fund model, intending to make it a new axis of development. A tax exemption for active ETFs that aims to boost uptake will be effective from the beginning of 2025.
Until the early years of this decade, Exchange-Traded Funds (ETFs) were defined as “listed index funds”. Developed initially in the United States over 30 years ago, their main objective was to replicate a stock index through a portfolio composition which strictly replicated the chosen index. These are now called “passive ETFs” to mark the difference with “active ETFs” which intend to outperform the index through the intervention of a portfolio manager. “Active ETFs are not that new. But their recent notoriety comes from the fact that investors have become aware that they can offer returns superior to ETFs that simply track an index,” explains Jean-Marc Goy, president of the Luxembourg Investment Funds Association (ALFI).
In the vast majority of cases, active ETFs also adopt a benchmark index, but primarily as a point of comparison. Unlike passive ETFs that must faithfully replicate the chosen index, active ETFs have the flexibility to deviate from it. Indeed, the manager has the freedom to choose stocks and bonds not included in the benchmark index in an attempt to outperform it. The investor, therefore, benefits from the hope of higher gains, at a still reasonable price. However, in the case of an active ETF, the risk of underperformance is not zero, depending on the manager’s choices. As BlackRock recently highlighted, market volatility and ambient uncertainty also generate more significant performance gaps between companies, sectors, geographical areas, or asset classes. A situation which presents more opportunities for managers to obtain an index-beating return.
Figures collected by Morningstar show the recent and growing success of this “new” asset class. From January to September 2024, flows into active ETFs in Europe stood at 11.8 billion euros. The British consultant points out that this is a new record. In 2023, the collection had brought in 6.8 billion. And by the end of the fiscal year, total assets under management should exceed 40 billion euros. They still represent only a small part of total European ETF AuM (2.4% at the end of September) but their growth is accelerating, with a share of total flows now close to 7%.
Jean-Marc Goy, President of the Luxembourg Investment Funds Association (ALFI)
Luxembourg, already the second home for ETFs in Europe
Luxembourg is convinced of the increasingly important place these financial products will take in investors’ portfolios. With a market share of 17% in European ETFs (282.3 billion euros out of a total of 1,718.7 billion at the end of June 2024), the Grand Duchy’s financial center ranks second behind Ireland, and far ahead of Germany and France as a home for such products
“For a fund manager who wants to market an ETF in different countries, we remain the jurisdiction of choice."
“Financial, political, and social stability remain obvious assets, as well as our status as a world leader in cross-border activities,” comments Jean-Marc Goy. “For a fund manager who wants to market an ETF in different countries, we remain the jurisdiction of choice.” All the more so because the Luxembourg financial center benefits from the broadest expertise in Europe for active fund management. Nearly all major global asset managers have active fund platforms in Luxembourg, which acts as their competence centre, notably for global fund distribution. This expertise can easily be transferred to ETFs, as variation of UCITS product.
The elimination of subscription tax is a big step forward to ensure the launch of new funds from Luxembourg.
Starting in January 2025, active ETFs domiciled in Luxembourg will also benefit from the elimination of the subscription tax. Passive ETFs and index funds have already benefited from this measure for over ten years. “This is a big step forward to ensure the launch of new funds from Luxembourg,” confirms Marie-Sophie Pastant, Head of Index Management and ETF at BNP Paribas Asset Management. “Luxembourg enjoys a very good reputation among investors and already has extensive experience in the ETF domain.”
Marie-Sophie Pastant, Head of Index Management and ETF at BNP Paribas Asset Management
The choice of young investors
The recent enthusiasm for active ETFs is linked to three major inherent characteristics of the product: flexibility, transparency, and affordable rates.
Flexibility: Continuously listed on stock markets, ETF fund shares can be traded intraday, like a stock. For traditional investment funds, on the other hand, one must wait for the daily publication of the NAV (net asset value) to set a price.
Transparency: Active ETFs are obligated to provide every day the exact weight of the different assets that compose the fund. An important metric, enabling the investor to make decisions with perfect knowledge of the product they are buying.
Rates: Active management tends to drive up costs compared to passive ETFs, but in reasonable proportions. The attractiveness of ETF rates is explained by simpler structures (automation and standardization), trading through stock platforms rather than financial intermediaries, and more flexible management linked to the product’s transparency characteristics.
These ETF product characteristics particularly appeal to new digitally-native generations of investors, who are less likely to go to an intermediary to buy fund products. “Online platforms are efficient and popular and ETFs are the appropriate investment vehicles for this technology,” analyzes Marie-Sophie Pastant. “They thus respond to the wishes of young investors who appreciate their immediacy, the simplicity of building portfolios, and the autonomy they offer.” The investment objective remains the same, to save up or secure one’s retirement, but through products from which one can exit more easily.
Jill Rootsaert, Head of ETF Distribution Benelux at J.P. Morgan Asset Management
A tool for democratizing finance
Labeled UCITS, European ETFs meet the strictest investor protection rules, particularly the diversification requirement. As such, they suit both retail and institutional investors.
we will see an evolution towards retail in the coming years, it is a true tool for democratizing finance.
“In the United States, it is more embraced by retail investors already. In Europe, however, the vast majority of investors remain professionals. But we will see an evolution towards retail in the coming years, it is a true tool for democratizing finance,” observes Jill Rootsaert, Head of ETF Distribution Benelux at J.P. Morgan Asset Management, one of the main promoters of active ETFs, globally.
The advantages seem obvious. And there is nothing to suggest that the rise of active ETFs will play to the disadvantage of traditional investment funds. In the United States, their strong growth is partially linked to the transformation of mutual funds into ETFs. “This is less the case in Europe, where the majority of UCITS ETF grew their AUM from scratch,” insists Jill Rootsaert. She also notes that in J.P. Morgan’s activity, no cannibalization of classic investment funds has been observed. “The trend is rather to see our clients invested in passive ETFs transfer their assets to either ou active ETFs and/or our active mutual funds as both leverage the same capabilities just with different risk flavours.”
Active ETFs are here to stay. They are likely to evolve, probably taking more and more liberties with the indices they choose as a benchmark, allowing managers greater latitude in their choice of assets. They also make it easy to create thematic products and will logically become a reference for strategies related to the environment and climate. This product possess all the ingredients needed for a bright future in European finance. And can also be one means to support the ambitions of a Savings and Investment Union.