Arrival of active ETFs a likely winner for local investors and SGX

THE first actively managed exchange-traded fund (ETF) will list on the Singapore Exchange (SGX) at the end of this month, coming shortly after new rules allowing for such instruments were unveiled.

It marks an interesting evolution in the local investment landscape that is likely to be beneficial for both retail investors and SGX, as a wider range of offerings will become available on the local bourse.

Retail investors will now have a cheaper and more liquid alternative to the usual actively managed unit trusts offered by advisers.

For SGX, having a wider range of products could attract the attention of more investors who sometimes lament over the stable but unexciting offerings available in the local market.

Better distribution channel

The availability of active funds via the ETF route instead of the usual distribution channels is clearly good news for retail investors, who might otherwise invest in unit trusts that are sold to them by advisers or through various platforms that have different fee structures.

Unit trusts, for example, typically come with front-end loads that can be as much as 5 per cent.

Such funds also have higher recurring management fees – ranging from 1 to 2 per cent of net asset value (NAV) per annum for active funds – as a significant component also goes back as trailer fees to the fund distributor.

ETFs, on the other hand, represent a more cost-effective option.

Singapore’s first active ETF – the Lion-Nomura Japan Active ETF (Powered by AI) – has an annual management fee of 0.7 per cent. This is not much higher than the 0.4 to 0.5 per cent management fee that Lion Global Investors’ passive ETFs charge.

The impact of fees on investment returns can be significant over the long term.

In a hypothetical situation, an investor who invests S$100,000 earning a 4 per cent annual return would have nearly S$200,000 after 20 years, assuming the fund is subject to a 0.5 per cent annual fee.

But if fees for the same investment are raised to 1 per cent, the investor would have nearly S$20,000 less over the same period.

For more savvy investors who are self-directed, a distribution channel that charges less fees compared to similar active funds would clearly be preferable, and could also boost retirement adequacy.

Meanwhile, a wider range of products on the market can also allow investors to more easily build diversification into their portfolios.

Beyond cost-effectiveness and liquidity, active ETFs could potentially pave the way for more interesting products that some investors desire.

Unlike passive ETFs – which seek to track the performance of an index – active ETFs allow for investment managers to make investment decisions on the portfolio in a bid to deliver outperformance.

To beat the reference benchmarks, a skilled portfolio manager can perform bottom-up and top-down fundamental analysis to identify more attractive counters.

This may be appealing to some investors who seek a higher level of expected returns.

Singapore’s benchmark Straits Times Index (STI) has been relatively stable over the past decade, rising just 2.3 per cent in 10 years. When factoring in dividends, the market barometer would have delivered total returns of 49.1 per cent, or 4.1 per cent on an annualised basis.

Such stability may be prized by some, but investors seeking capital growth would look elsewhere, especially when considering other options abroad.

While the overall STI has been relatively flat, there are outperformers that could have delivered alpha for an active fund that managed to pick winners.

Last year, for example, the STI delivered total returns of 4.7 per cent. But the top performing counters – Sembcorp Industries and Keppel Corp – each delivered 61 per cent returns. Others among the top 10 constituents also delivered double-digit total returns.

If active ETFs on the exchange are able to select the right stocks to outperform market benchmarks, it could potentially generate greater interest from investors and boost activity on the exchange.

Ecosystem benefits

In a report last year, management consultancy Oliver Wyman noted that total ETF assets under management (AUM) in US and Europe had grown at a compound annual growth rate of around 15 per cent between 2010 and end-2022 – around three times faster than traditional mutual funds.

It added that the ETF landscape is just embarking on its next stage of growth, fuelled by the rise of active ETFs.

Oliver Wyman described active ETFs as a “revenue opportunity for the industry that asset managers cannot ignore – irrespective if they are active in the ETF space today or not”.

The consultancy forecasts ETFs to account for 24 per cent of total fund assets by 2027, up from 17 per cent in 2023.

If a similar trend takes place in Singapore – especially with the availability of active ETFs going forward – there could be greater benefits for investors and SGX.

Current ETFs represent purely passive instruments, with popular counters including the two STI-tracking ETFs, SPDR Gold ETF as well as the Lion-OCBC Securities Hang Seng Tech ETF.

ETF AUM on the SGX stood at over S$10 billion in October 2023, roughly double the levels from end-2019, SGX said last month. It noted that the number of direct retail investors has doubled, while the AUM from robo-advisers has tripled over this period.

By contrast, the MAS asset management survey 2022 noted that the traditional retail segment, comprising authorised and recognised collective investment schemes in Singapore, stood at S$127 billion in 2022.

Of course, not everyone is confident enough to be self-directed, so other channels for fund distribution would still be relevant for some. But the numbers suggest room for the ETF space in Singapore to grow.

New active ETFs look to be a welcome addition, but it is also important for investors to note that active funds do not necessarily outperform their passive counterparts.

In fact, a Morningstar report last year indicated that, of nearly 3,000 active funds in its analysis, only 43 per cent survived and outperformed their average passive peer in 2022.

When considering a longer 10-year horizon, the report noted that only one out of every four active funds topped the average of their passive rivals, with success rates varying across categories.

Beating the market consistently is a challenge even for the best investors. This was partly the reason for the rise in low-cost passive index trackers that offer market exposure.

Even with more options available, investors should still be disciplined and allocate their portfolio in accordance with their desired sector or geographic exposure, rather than simply hope that an active strategy would be a sure-win bet that delivers outperformance.