In December, Luxembourg’s financial regulator the CSSF announced new rules around tax exemption and portfolio transparency for European active ETFs (exchange-traded funds).

Along with Ireland, Luxembourg is one of the main domiciles for exchange-traded funds and since its rule change there have been a flurry of new products coming to market. Here we explain what an active ETF is, how it works, and the pros and cons.

WHAT ARE ACTIVE ETFs?

There are three main categories of ETF in terms of how the underlying investments in the portfolio are chosen. Passive, active and smart beta. Passive ETFs typically track an index such as the MSCI World or S&P 500. Because they are simply looking to match the performance of an underlying index and professionals are not being paid to manage the underlying investments, they typically offer low fees. The vast majority of ETFs fall into this category.  

Active ETFs can invest in stocks, bonds and derivatives selected by the manager, and they usually aim to beat a relevant benchmark or index rather than just matching it.

A good example is JPMorgan US Value Equity Active ETF (JAVA), which aims to achieve a long-term return in excess of the Russell 1000 Value Index by actively applying a value style to a collection of US stocks.

Sitting somewhere between active and passive are smart beta ETFs, which use a rules-based approach to selecting a basket of investments but don’t actually employ a manager to select them.

Smart beta ETFs use filters or screens to tilt the portfolio towards factors such as value, growth, low volatility or momentum.

In the US, active ETFs make up 8% of all ETF assets under management and accounted for almost half of net inflows during 2024, according to E&Y, while they represent a small but growing element of the European ETF market.

HOW HAVE THE RULES CHANGED?

The first change the CSSF announced was regarding portfolio transparency, meaning active ETFs no longer need to publish what’s in their portfolio daily, rather the information can be published monthly with a maximum time lag of one month.

So-called ‘non-transparent’ ETFs have existed in the US since 2019, and by relaxing this rule the CSSF hopes it will stop other market participants from being able to replicate an active ETF manager’s day-to-day investment strategy as well as paving the way for a wider range of funds available to investors.

The second change involved abolishing subscription tax, so from 1 January thus year actively-managed ETFs are exempt from an annual subscription tax putting on a par with passively-managed ETFs.

Morningstar Passive research funds analyst Kenneth Lamont isn’t convinced the new rules will spur greater investor interest, however, as although they put active ETFs on a more equal footing with other investment vehicles they don’t provide a clear, sustainable tax advantage as there is in the US.

‘Luxembourg has backed the introduction of semi-transparent ETFs, and it’s expected that Ireland will follow suit. In theory, this could appeal to managers with high-conviction strategies who want to protect their proprietary strategies,’ says Lamont.

‘However, in practice, uptake is likely to be limited. A look at the US market shows semi-transparent ETFs represent less than 1% of active ETF assets under management.

‘One of the main selling points of the ETF structure is its transparency, and investors in the US have shown they value this feature with their investment choices,’ concludes Lamont.

WHAT DO ACTIVE ETFS OFFER INVESTORS?

Active ETFs can offer investors greater exposure and flexibility to a basket of stocks, bonds, derivatives selected by a manager, which can mean there is less concentration risk compared to passive ETFs which simply track a market-cap weighted index. By buying one of these products your exposure to winning stocks will increase, and some companies will have ended up with very dominant market weightings. 

Active ETFs also offer investors more transparency and liquidity than OEICS (open-ended investment companies) as like shares they can be traded throughout the day in real time rather than being priced once a day at a level you only find out after you’ve traded.

Admittedly most active ETFs will have higher operating costs than plain-vanilla passive ETFs, but compared to traditional mutual funds they often have lower charges. A key drawback is that, because this is a nascent space there is a significantly smaller selection of products to choose from than if you were looking at traditional funds or investment trusts.

Lotfi Ladjemi, vice president of ETF Distribution at Franklin Templeton, says: ‘With lower expense ratios and no entry or exit fees, investors can access professional management in a more cost-effective vehicle. The average cost of European active ETFs has declined, with representative costs dropping from 0.41% in March 2013 to 0.28% by March 2024, making them more competitive against traditional active funds.’

Among the best-performing European active ETFs over the past year is JPMorgan UK Equity Core UCITS ETF GBP (JUKC).

Launched in 2022, with £274 million of assets and a relatively low charges of 0.25%, it has 155 holdings and counts pharmaceutical giant AstraZeneca (AZN) and oil giant BP (BP.) among its top 10 holdings.

‹ Previous2025-04-10Next ›