ASIC called a halt to listing new actively managed ETFs in July, looking to review funds that do not disclose their portfolio holdings daily and have internal market makers.
Internal market making occurs where an ETF provider doubles as its market maker, buying and selling the products.
BlackRock’s ETF business, iShares, offers active ETFs in the US, where funds are obligated to disclose their portfolio holdings to the market daily to authorised participant representatives.
Providers of active ETFs in Australia include Magellan, Fidelity, Platinum, AMP Capital, Schroders, Antipodes and Legg Mason.
Christian Obrist, head of iShares, BlackRock Australia said BlackRock held back from entering the local market for active ETFs, being uncomfortable with internal market makers in Australia and the fact there are no regulatory requirements for daily transparency.
The asset manager does not trade ETFs, viewing internal market making as violating a division between “church and state” for most providers.
“It’s the market makers, global brokers, big banks – they have ETF trading desks, they make money by trading ETFs,” he said.
“We don’t. We make money off the management fee. Now that’s a very strategic decision that we say, okay, we’re going to unbundle those two things because for us, that’s kind of a conflict of interest if you do both.
“If I get more money by getting assets into the fund, but I also control trading, well then you might have some inherent conflicts of interest, because I might start opening that door a bit more and making it easy, maybe getting the fund to subsidise.”
In a report on exchange-traded products published last year, ASIC said likewise: “The use of internal market making to provide liquidity in an ETP presents a number of conflicts of interest that must be carefully managed.”
He commented there should be multiple market makers for each fund, because with more trading, comes more competition, to the benefit of investors.
Active managers look to gain from ETF rise
Australian ETFs now hold around $56 billion in funds under management (FUM), while global ETFs held about $5.5 trillion as at the end of April.
The Australian ETF industry hit $50 billion in July, smashing provider BetaShares’ previous outlook that the sector would gain $50 billion to $55 billion by the end of the year.
Funds in Australian ETFs have been forecast to reach $60 billion by the end of the year in a new VanEck report, with Stockspot calculating it will rise to $100 billion by 2022. Rainmaker has projected the segment will surge to $600 billion by 2030.
However, despite its spurts of growth, index investing still only represents a small portion of trading volume – for every $1 traded for ETFs, Mr Obrist estimated around $28 is traded actively. Internal market making funds only represent around 6 per cent of FUM in ETFs.
Mr Obrist said active managers have sought to collect a piece of the action, using ETFs as packaging to distribute their own strategies.
“So, you know, I suppose if you’re an active fund manager, you see this growth,” he said.
“And then you ask yourself, why is it just because it’s passive over indexed? Or is it because it’s on the exchange? Because there there’s this whole list of benefits, and one of them is accessibility.
“I think it’s about access, and it’s another venue to distribute your product.”
Product proliferation is one of a few challenges facing the ETF sector as it grows, Mr Obrist said, along with issuer proliferation as everyone “wants to jump on the bandwagon.”
“You see all of these active managers coming in? I think you know, not every week, but every couple of weeks there’s a new fund,” he said.
“Globally, you’ve now had the active managers who haven’t been involved at all with ETFs, in recent years, all get involved.”
He commented as the largest provider of ETFs, BlackRock has a responsibility to contribute to a healthy landscape for ETFs and to not mislead investors, ensuring they buy products they understand.
BlackRock has added to its public policy team in Australia, which Mr Obrist said will tackle regulator engagement and “be part of that conversation to shape that ecosystem,” preventing an environment that allows “inefficient, faulty products to evolve in the market and lead to bad outcomes for clients.”
“We need to make sure that all of the parameters that provide that framework are the right ones, and where we live and breathe by our principles of transparency,” Mr Obrist said.
“Ensuring where it’s possible to have multiple market makers, that there’s just no hidden gimmicks, that people really get what they buy.”
