Active ETFs: Some frequently asked questions

Active ETFs¹ and similar exchange-traded products are booming. At the end of July, year-to-date net inflows set a record of $88.23 billion and assets under management were $404 billion – up from $202 billion at the end of last year, according to data provider ETFGI.

"For asset managers  hoping to launch active ETFs, they will find that the ecosystem is very different from that of traditional mutual funds", says Véronique Dang Vu, product engineer at Societe Generale Securities Services (SGSS).

SGSS currently has 300 ETFs under administration and supports ETF managers from locations in Ireland, Luxembourg and  France. The firm’s expertise spans trading and post-trading processes. 

Questions, decisions and actions

Part of the ‘induction’ for the asset managers is to get to know the key players in the ETF market, including authorised participants (APs) – usually large banks, who are market makers and financial intermediaries with the right to create and redeem ETF shares.

Asset managers also have to decide whether to launch a physical-replication model for their ETF (whereby they own the stocks and bonds in the ETF index), or a synthetic-replication model (whereby the ETF recreates the underlying index using derivatives).

For instance, says Dang Vu, at a time when ESG is in such intense focus, synthetic ETFs may not be relevant – after all, to vote as part of an engagement strategy, you need to own the shares. Conversely, physical replication is more complex and costly to implement if the tracked index includes non liquid stocks / bonds (emerging markets…).

Fund managers also need to optimise the management of the ETF according to the replication model selected – something that has cost implications. For instance, in the physical replication model, the fund has to trade all the components of the index each time there is a subscription or redemption, so managers must identify how they can trade the basket every day while keeping costs down.

“Success with ETFs is achieved through specific criteria, such as low tracking error, low costs and liquidity,” says Dang Vu. 

Another important pre-launch question is location, meaning where to list the ETF and where it should be domiciled. This is front-of-mind for many ETF providers and Dang Vu reports that one of the most frequently asked questions by asset managers looking to launch an active ETF is whether to domicile in Ireland or Luxembourg, the two largest EU cross-border fund locations. 

“There is a tax treaty between Ireland and the US, so some firms choose to domicile in Ireland in cases, for example, where they’re replicating US or MSCI indices on a physical ETF. For those who don’t have US securities or who have chosen a synthetic model for their ETF, there’s no financial advantage in choosing Ireland.”

Replication and domiciliation are just some of the main questions that SGSS often hears. Dang Vu says:

“Clients need the support of people who understand the ETF world and often come to us because they’re looking for a package of all the services they require – and we have the full range of everything they need to meet their objectives, from SG investment banking services (AP, swap counterpart…) to dedicated post-trading ETF services such as a white-label AP portal.”

To read more about SGSS’ ETF services, click here.

Article published in Funds Europe.

¹ETF : Exchange Traded Fund.