Decode active ETF misconceptions with J.P. Morgan. Learn how ETF transparency, cost and liquidity help bridge the perception gap for institutional investors.
Active ETFs are products caught in a perception gap – seen as the future of investing by some institutional investors, but less well understood by many others.
This divide is reflected in our recent survey of 70 fund selectors and decision-makers, representing pension schemes, insurers, consultancy firms and foundations across Europe, which found that 73% are yet to fully embrace active ETFs.
So, do perceptions match the reality of the active ETF experience? Our survey explored active ETFs from the institutional perspective examining how these products can be deployed in long-term, institutional investment strategies.
ETF cost and value: Are active ETFs worth it?
The cost of active ETFs is a common objection among institutions. Often managing large portfolios under tight cost constraints, institutional investors question whether active ETFs can deliver sufficient long-term value in return for higher fees.
Reality: The costs of active ETFs often aren’t that different. Many active ETFs are priced with fees that rival passive ETFs, and fees are typically lower than active mutual funds, providing a useful middle ground between the two ends of the cost spectrum.
It’s also important to remember that active ETFs offer the potential for alpha, meaning that higher fees could, and ideally will, be easily outweighed by excess returns over the long term.
Exhibit 1: Total Expense ratio of active and passive UCITS ETFs
Another common concern relates to risk. Some institutional investors find the simplicity of passive ETFs reassuring during periods of market volatility, with low costs and predictable index exposures seen as a stable foundation to navigate uncertain conditions.
Reality: This philosophy assumes that index predictability automatically equates to lower risk, overlooking the index biases and anomalies that are embedded in passive strategies.
Active ETFs provide institutional investors with tools to mitigate inherent index risks that passive strategies simply can’t. In fixed income, for example, passive indices will overweight the most indebted issuers. Active ETFs allow managers to make more judicious selections during periods of market stress or regime change, steering portfolios towards higher-quality issuers to mitigate hidden risks.
In equity markets, index concentration close to multidecade highs is exposing passive investors to significant risks. Out of the 1,400+ stocks in the MSCI World Index, the 10 largest stocks by market capitalisation currently represent 25% of the index, up from 9% in 2014*. As returns begin to broaden out, market-cap-weighted trackers lack the ability to adapt quickly.
As a result, in both fixed income and equities, choosing to invest passively is an active decision that could introduce less obvious, but impactful risks into portfolios.
ETF transparency and history: Can active ETFs be trusted?
Active ETFs are perceived as being less transparent than passive ETFs by some institutional investors. Institutions also worry that the relatively short history of active ETFs in Europe limits their ability to evaluate long-term performance and reliability. A perceived paucity of proven strategies raises further questions about their suitability for institutional-grade portfolios.
Reality: Transparency is one of the standout features of all ETFs, and active ETFs are no different. Full, daily disclosure of holdings is a regulatory requirement, which far exceeds the quarterly disclosures of traditional mutual funds. For institutions, this level of reporting provides a granular view of underlying assets, enabling rigorous portfolio monitoring and alignment with compliance standards.
ETF transparency can be particularly invaluable for ESG mandates, allowing institutions to track exclusion policies and sustainability goals in real time and feel confident in the alignment of active ETF holdings with their objectives.
As for performance track records, while active ETFs may be relatively new in Europe, their underlying strategies are not. Many active ETFs replicate or transition preexisting active strategies with years of history and performance. And the well-established US market for active ETFs provides another robust body of evidence that can demonstrate the reliability and scalability of active ETFs for long-term institutional portfolios.
ETF liquidity and scalability: Are active ETFs institutional-grade?
Perhaps the biggest misconception is ETF liquidity. Many institutional investors, with investment horizons measured in years or decades, simply don’t think that the intra-day liquidity offered by active ETFs is something that is important for them.
This perception is shaped by the belief that stability and lower costs are more of a priority to large-scale, long-term investors than the ability to trade frequently. These concerns are reinforced by doubts that active ETFs have the ability to handle large institutional trades, especially during periods of high market stress when liquidity is most critical.
Reality: Even for long-term institutional investors, the intra-day liquidity provided by active ETFs can provide several important advantages. Efficient pricing and price discovery–which both benefit from high levels of liquidity–can provide a crucial edge when entering or exiting positions, while ETF liquidity further helps to boost portfolio transparency and support investor confidence during times of market stress.
ETF liquidity also provides the flexibility to make tactical adjustments to long-term strategic portfolios. For example, active ETFs allow for quick and cost-efficient rebalancing in response to changing macro conditions or updated investment strategies. Also, when shifting between asset classes or strategies, active ETFs provide a liquid, flexible bridge, allowing institutional portfolios to maintain market exposure without the operational burden of setting up new segregated mandates.
Daily liquidity isn’t just about trading. It’s a strategic tool that can improve risk management, operational flexibility, and confidence in navigating market challenges.
Active ETFs – Bridging perception and reality
Our survey suggests that many institutional investors still have doubts about using active ETFs in their portfolios despite the many advantages that they can offer. These advantages include competitive fees and high levels of transparency, as well as intra-day liquidity, which can be a key benefit even for long-term institutional portfolios.
Against an investment backdrop of index concentration, macro volatility and shifting ESG priorities, active ETFs increasingly stand out as an important tool for institutional portfolios. Bridging the gap between active management and index-tracking, active ETFs offer the best of both worlds—combining the judgement and precision of active management with the transparency and liquidity of the ETF wrapper.
Our view is clear: it’s time to rethink how these products can play a central role in meeting the complex demands of today’s institutional portfolios. Institutions willing to bridge the perception gap can build a strategic advantage with active ETFs.
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