Podcast: What's driving the recent growth in active ETFs?

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Nick King (NK): What was very clear is, is that the primary objective should be that alpha. But at the same time, clients were very interested in sustainability, felt that we had very interesting research. We’re recognized as a leader in this space. So it was important that there is a degree of sustainability embedded within the product and there should be a guaranteed minimum but also being able to dial that up and down without compromising the primary objective of alpha.

Welcome to a new episode of the Robeco Podcast.

Erika van der Merwe (EM): It’s been a landmark year for active exchange traded funds. More than 300 new active ETFs have been launched so far in 2024, and around EUR 200 billion investor flows have made their way into this market segment. The changing geographic trend is also interesting. The industry is now finally growing beyond the US with healthy growth in new European and APAC domiciled active ETFs.

So why have investors become increasingly eager to get exposure to these not-so-passive investment vehicles? And for asset managers, what does it take to get a successful active ETF product up and running? Wilma de Groot and Nick King are my guests for this discussion. Wilma is Head of Core Quant Equities and of Factor Investing Equities at Robeco and Nick heads Robeco’s ETF business. Welcome. So good to have both of you here.

Wilma de Groot (WG): Thanks, Erika.

Nick King (NK): Thanks, Erika. Great to be here.

EM: Well Robeco has just launched its first active ETF products, adding to the growing list of European providers in this area. So we have plenty to discuss around that as well: your ambitions in this field and your experiences so far. But first, Nick, if we can just sort of get things started by discussing the active ETF market. So we know by now the global ETF market is a force to be reckoned with. So how significant is the active portion?

NK: The overall ETF market is huge. Total assets globally stand at around USD 14 trillion, so a huge volume of assets. And the active ETF segment is a rapidly growing part of this. So globally, assets in active ETFs now stand at around USD 1 trillion, which is around 7% of total assets.

EM: Right.

NK: Now, Europe is lagging the US in this, as we’ve seen with the growth of the overall ETF market. US has really led this. But, again, this is growing very rapidly. So active ETFs in Europe currently stand at around USD 50 billion: so already quite a really significant sum of assets. And that’s around 2.5% of total ETF assets in Europe.

EM: Just to stop at the idea of active ETFs: the ETF traditionally is considered to be a passive item. So what’s active about this and how is it a different from a typical mutual fund?

NK: So I would say that historically most of the assets within ETFs have been passively managed. But investors have really started to see some of the benefits of the ETF wrapper and are increasingly now looking to use this to access both their their passive and active investments. So if we think about some of the benefits of the ETF wrapper, these really come from the fact that the ETF is structured as a security.

So what this means is that it’s available to any client through their broker. It also means that because it’s traded on exchange, they’ve got a variety of ways in which they can trade this. But importantly they can trade it at any point during the trading day, and they can trade it at a known price. If we compare this to mutual funds, where you generally find out the following day what you’ve actually paid for that transaction.

EM: So Wilma, Nick has just described there how an ETF is different from a mutual fund and why it would be appealing. But what do we mean by the ‘active’ component here? I mean for years you’ve been working on enhanced indexing. So I would imagine it’s a similar idea with smart beta for example.

WG: You could say with a passive ETF, we replicate a particular index and for clients it’s is an easy way to get – if they invest in a passive ETF – exposure to a particular market that’s being replicated. And I think it offers many advantages. It’s relatively cheap, it’s transparent. It offers investors exposure to this diversified market at relatively low cost. But it also comes at some disadvantages because if you take costs into account, you often get up end up with an index minus return –

EM: – guaranteed to underperform.

WG: And it’s also very challenging to integrate sustainability. Well, if you just replicate a market cap index like MSCI world or even a local index like the AEX index, you just get the return of that index without taking sustainability into account. Obviously you can replicate also a sustainable index. But that is in fact an active choice already to replicate such an index.
And often the sustainability indices, they are one dimensional. So you get one form of sustainability basically. Well we observe that our investors often like multiple dimensions of sustainability. So if you give a little bit room for that, which you can do with an active ETF, then you can actually use that room to deviate slightly from the main index and actually use that to attract to invest in more attractive stocks and get there for an index plus return, and also use it to increase the sustainability profile of the portfolio. And yeah, with an enhanced indexing setup, you actually do that by still keeping the advantages of passive, so still a diversified portfolio at relatively low costs.

EM: What I hear from what Wilma says is that there is likely various degrees of activeness in active ETFs. It’s up to the constructor of the product, right?

NK: It is. And I think what was just summarized there is that with active ETFs you can get the benefit of both. You can get some of the convenience of the ETF wrapper that I was just describing with the benefits of active management. But as you say, the range of activeness of active ETFs varies quite considerably. And actually what we see in Europe at the moment is the vast majority of the active ETFs in Europe actually aren’t very active.

They are primarily enhanced index type products, which is why I think we’ve got a very strong and compelling proposition here because this is an area that we have very strong track records, a super team. And overlaying that with our sustainability credentials, I think we’ve got a really strong proposition with the 3D ETFs that we’ve just launched.

EM: I still have some questions around just the growth that we’ve seen in the market because, Morningstar reports that of all the ETF launches so far this year, the majority have been active ETFs. So something is happening, whether it’s on the supply side, but presumably also on the demand side. Investors are really hungry for these kinds of solutions. Why?

NK: I would say it’s this convenience of the ETF wrapper. But also being able to benefit from the potential of outperformance as well. I would say that that ETFs have already evolved to such an extent that you’ve got such a wide range of different options on the passive side. You can really buy very granular passive exposures. There is limited innovation that can happen on the passive side. So this to me is most natural next step for ETFs – is to be able to leverage the intellectual property that active managers have.

EM: And what are investors looking for? I know you’ve been speaking to clients. You’ve mentioned sustainability as something for which they’re hungry. But Track Investor does an annual global survey. According to them, the top reason why investors might go for active ETFs is for diversification. Does that make sense in terms of the conversations you have?

WG: I think it makes a lot of sense because what we also see up to now, if we look at our enhanced indexing strategies that have been live for 20 years, we see actually that the majority of the investors that choose for this strategy up to now are actually institutional investors, like pension funds, because it fits very well in the core of their portfolios.

And what we see if we look at other types of investors like wholesale or retail investors, they often either choose for passive or they go for highly active. And I think with bringing these types of enhanced indexing strategies to the market in an active ETF, for his group of investors, it’s now also very fortunate to invest in these enhanced indexing strategies, and actually also here get these benefits of an enhanced indexing strategy without moving to fully highly active with often also higher costs involved.

NK: Yeah I would agree with that. I think one of the beauties of an enhanced index ETF is it can appeal to those clients that are looking for an alternative to passive, but also those clients that actually want a lower cost alternative to fully active products as well. So there’s quite a broad range of clients that I think will be interested in this type of products.

EM: So Nick and Wilma, I believe you’ve been working on your launch for about a year or more than a year. What was the strategic thinking behind going for this?

NK: Well, we’ve observed trend of the growth of active ETFs. And we also have demand for new ways of accessing our investment IP in different vehicles. So for many years, we’ve obviously been offering our investment capabilities through mandates, through mutual funds. ETFs now provide another way to be able to provide access to our clients.
And as well as the growth we’ve already seen, we expect this growth to actually increase quite significantly. In fact, Blackrock, who is one of the – or the largest ETF issuer globally, they recently predicted that the global active ETF market is actually going to grow to 4 trillion by 2030. So we expect this growth to continue at quite a pace. And we want to be part of this. And clearly our clients are demanding this wrapper and we need to evolve our capabilities to meet their evolving needs.

EM: So that makes sense. But how does this fit into the rest of the business? How does it interact with all the capabilities? And to be really cynical, are you not at risk of cannibalizing what you already have on offer?

NK: So I would say that products are designed to be complementary rather than cannibalizing anything. I think that mutual fund will continue to coexist alongside ETFs. Different clients will prefer different wrappers and use the products in different ways. So I think this really is complementary as opposed to creating any form of cannibalization. But if clients do have a preference for the ETF wrapper, then it’s better that they move to one of our ETFs than moving elsewhere.

EM: Indeed, Wilma, you’re probably a case study of how this works.

WG: Yes, because I think what’s also nice to add here is that the advantage of our quant strategies – and is actually that we can develop customized solutions for different groups of investors.

EM: And you’ve been doing this for a long time –

WG: – already for a long time, yes. So we have already these different types of strategies in place. And I think because we believe – we don’t believe in a one-size-fits-all approach, right? We like an approach that different investors have different needs and we customize our strategies towards that. And I think with the quant strategy, that’s also very suitable to do that. And it fits very much with the Robeco Investment Engineers’ approach as well.
And what we therefore have decided is that for these ETFs, for the 3D enhanced indexing ETFs, it’s also to really tailor-make it for the investors that we think would be interested in these type of strategies. And therefore they are also slightly different from the other enhanced indexing strategies that we already have live in different types of formats.

EM: So indeed, Nick, this is your starting point with this initial launch – is that it’s a combination of its equity and these are quant products, that combination. Why was this your starting point?

NK: As we discussed briefly before, enhanced indexed products are the best selling products in the European active ETF space. So given the really strong capability we’ve got in this space, this felt like a very sensible place for us to be starting. Also, you know, quant strategies generally lend themselves to transparency. They’re generally quite diversified strategies. They’re liquid. So these characteristics generally work well for ETF products.
And what we’ve been able to do is bring up the three ETFs that leverage the existing enhanced indexing capability. But then we’ve also brought the Dynamic Theme Machine ETF to the market, which I think is really showing some of our next-gen quant capabilities. Actually some of our most cutting-edge research as well.

EM: Some intriguing names. Let’s begin with the 3D range. Wilma, what’s the thinking or the philosophy with this range? Three ETFs within this bundle.

WG: So maybe just briefly on the – or high level on the concept of enhanced indexing. I already mentioned we take the index weights as a starting point, and then we take small deviations from that index. So we overweight attractive stocks. And that’s based on our quantum approach that’s based on decades of experience that we have built up within Robeco to select what are the most attractive stocks that do well in the long run, and we underweight the least attractive stocks.

And at the same time we also take sustainability into account. So we overweight the stocks that are attractive from a return perspective but also from a sustainability perspective. And we take – we have very tight risk controls in place. So we make sure, for example, that if you look at the weight of sectors in the index, we don’t deviate too much from that. And the same holds for countries and a range of other measures that we look at.
So with that we stay close to the index and we aim for stable outperformance in the long run. That’s actually also what we’ve seen: if we look at this long term track record of 20 years, we’ve seen that in 15 out of the 20 years, we’ve shown a higher return than the return of the index. And it doesn’t mean that you have a positive return or high return in the index in every year. But in the majority of the years, no matter whether it’s an upmarket or downmarket, we see that the strategy is quite robust for that.

EM: So I’m not a mathematician, but is this all about optimizing or maximizing the three dimensions of return, risk and sustainability?

WG: Exactly. And this actually also a new concept that we introduced because contrary to where you could have a strategy in place that you say like, “okay, I want to have some particular constraints on sustainability,” and then optimize for your return and your risk profile, we really balance the three concepts simultaneously. So risk, return and sustainability, where we also take a multi-dimensional look at sustainability where we have that approach.

So for example, we ensure that the portfolio has a lower carbon emission than the benchmark, but also we ensure a better ESG profile. We also take the Sustainable Development Goals framework into account. So we don’t invest in the stocks that contribute negatively to those goals. We also take exclusions into account and we have an active ownership approach, so we also actively vote and engage with companies we invest in.

And the 3D concept comes in place because if you think about carbon as an example, we aim for a 30% carbon reduction in these strategies, but this can be dynamic. So sometimes it can be that we have a bit more reduction than the 30% in place and sometimes a little bit less. And this depends on what the interaction is of stocks in terms of their return profile and the sustainability.

So for example, sometimes you have that the most attractive stocks that we select are really also stocks that have a low carbon profile. But sometimes it can be that these stocks have a somewhat less attractive carbon profile. And then to avoid that, you need to invest in unattractive stocks. We make this balanced trade off, which means that in the long run we still have the 30% carbon reduction,

Also, we have an airbag in place that we always have an at least 20% carbon reduction in place because this is a topic that we see that our investors think is very important.

EM: So you’ve committed to that?

WG: Yes.

EM: So is that an equal priority to the 3Ds of risk, return sustainability?

NK: I would say it’s this interaction of sustainability and return, which is really what makes this approach really quite unique because we’re able to adjust the level of sustainability in the portfolio depending on whether or not that’s aligned with the alpha objective of the products or not.

So there’s always going to be that baseline of sustainability uplift, as Wilma described. But I think being able to dynamically adjust that over time, to prioritize the alpha within the product is also a really important feature of the product and one that, as we were going through the design process, was very, very important to clients as well.

EM: That alpha is a primary driver?

NK: Yes, absolutely. So as we were doing our market research and looking to understand what would make our clients interested in these products, what was very clear is that the primary objective should be that alpha. But at the same time, clients were very interested in sustainability, [they] felt that we had very interesting research. We are recognized as a leader in this space.

So it was important that that there is a degree of sustainability embedded within the product and there should be a guaranteed minimum but also being able to dial that up and down without compromising the primary objective of alpha, [that] was a clear message. And I think by launching these products the way we have I think we’ve really managed to address that need. And as I say, I think it’s quite unique compared to other products in the market.

EM: And you’ve provided three flavors. Again, is that based on, on market research that you’ve got the global the US and the European versions?

NK: Yes. The target market for these will generally be using these as building blocks within multi-asset portfolio. So having the different geographical variants will allow clients to express their geographical views and use these as a set of building blocks. So these are the first three; we’ve launched a US, a European and a global product. But there’ll be more building blocks coming over time as well to round off that suite of products.

EM: And then the fourth launch in this very first batch is the wonderfully named ‘Dynamic Theme Machine Active ETF’. Wilma, what’s this all about?

WG: Yeah, I think this a really very nice concept. It’s very highly innovative, it’s artificial intelligence based, it’s a multi-thematic strategy. So it uses natural language processing techniques to identify emerging themes in a very early phase. So of course we’ve seen the rise in thematic strategies that aim to capture these long-term growth trends, for example, trends like internet or social media.

However, what you see often is that these strategies can be concentrated in specific sectors for a very long time. And therefore also the risk of these portfolios can be quite high, because if these themes at some point change, then that can also lead to quite disappointing returns at the same time. So to make sure that you also get out early in these kind of themes we use this dynamic setup, and it’s based on a massive amount of data that we use to determine these different themes.

And like I said, the techniques that we use, we use like company earnings reports, management discussions, etc. and then we have that tool that we use to select these emerging themes. But also we use these different types of tools to select which type of stocks you best can invest in within these themes. And we see that leads to a very active portfolio at the same time, but still diversified in the sense that it’s not concentrated only in particular sectors.

EM: Nick, not your common thematic fund here.

NK: No, this one I think is really unique. There’s nothing like this in the markets at the moment. There’s a large number of single thematic products that may invest in themes like clean energy or cybersecurity, for example. But there’s very little in the multi-thematic space and there is certainly nothing as dynamic as the approach that this product takes. I think that it’s been quite clear from the data, that the single thematic products that have been launched to-date have generally been launched fairly late in the evolution of a theme.

This means that the stocks that the product invests in generally have pretty stretched valuations by the time the product comes to market, which means the clients are getting into this theme pretty late, which then doesn’t result in a great financial outcome for them. Whereas what we’re doing with this product, as Wilma was saying, is really identifying the themes very early in their evolution and then rotate through these as they evolve and as the attractiveness of these themes changes.

EM: You’ve begun this journey. You’ve really achieved a great deal with this initial launch. Now, looking back over the past year, what would you say it takes to get to this point, what would your learnings be for other asset managers who might be thinking of this? Because you’re a mid-size player, you are in a very tough market competing against these very big household names.

NK: Yeah, well, it’s a super competitive market and the key thing is really to be able to offer products that are going to meet a specific client need, something that’s different to what’s already available in the market. But again, whilst the ETF market itself is very well established, the active ETF market, particularly in Europe, is, I would say, just emerging. So whilst we know there’s a number of our competitors coming to market, actually I think that we are still here fairly early with some really unique products and therefore have a really good chance to be a good success in this market.

EM: Nick, you’ve given us a few hints, but in brief, what are your future plans for ETFs?

NK: The four products that we’ve launched so far are just to start. We will be adding to the 3D range over the coming months. Actually the next product we plan to launch is the emerging markets version of the 3D strategy. That should be launching early next year, Q1 next year. Very excited for that launch as well. EM enhanced index is an area that we’ve got a particularly strong track record. So I think bringing that to market as an ETF is going to be great.
And then looking forward later into the year, we’ll switch focus to fixed income ETFs. We want this to be a multi-asset class ETF platform. So that’s going to be the next focus. There’s thinking about the products that we want to bring to market. Again there’s going to be some operational and technology build required to bring that to market. So that’s going to be the focus for 2025.

EM: Wilma, a final word from you to you. What would success look like in this area of active ETFs at Robeco?

WG: Yeah, I think it would be a success. First of all, of course, if the performance of these type of strategies are in line with our expectations because that’s in the end what we aim to do, of course, for our investors. And also, of course, that investors find a way to these type of strategies and also see the need for the use in their portfolios. I think that combination would be fantastic.

EM: Wilma and Nick, congratulations and super having you. And thanks for joining us.

WG: Thanks, Erika.

NK: Thank you very much.

EM: And to listeners, thank you for being here with us. We publish a new episode every month covering a range of investment related topics. This podcast and Robeco’s Markets podcast, In Tune With The Markets, are available on all major podcast platforms and on the Robeco website. If you subscribe, you’ll receive a notification as soon as the new episode is published. Now, in the meantime, please rate the show and share the show link with a friend. Until next time.

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