Capital Group wades into active ETF model portfolio market

The world’s largest active asset manager is throwing its weight behind an emerging trend at the confluence of two fast-developing themes: model portfolios built entirely out of actively managed exchange traded funds.

Los Angeles-based Capital Group, which manages $2.8tn, largely under its American Funds brand, is following the lead of Dimensional Fund Advisors in offering eight model portfolios constructed entirely out of its own active ETFs.

“This isn’t a novel solution, Dimensional already offers active ETF models. But this is the big trend in models and we’re going to see a lot more active ETF models going forward,” said Bryan Armour, director of passive strategies research, North America at Morningstar. 

Model portfolios, which allow financial advisers to simplify their investments by utilising a pre-constructed mix of funds designed to match a specific risk level or investment goal, have become increasingly influential in the US in recent years.

Research published in December by State Street Global Advisors found that US financial advisers invest 39 per cent of the assets they manage in model portfolios, up from 32 per cent three years ago.

Active ETFs are also in the ascendant, grabbing a record 28 per cent of overall net inflows to ETFs in the US last year, taking their market share to 8.1 per cent.

Both passive and actively managed funds are widely used as the building blocks of these portfolios. Traditionally the latter were mutual funds, but Martin Small, BlackRock’s chief financial adviser, said in December that the expanding “active ETF toolkit [has] transformed what model portfolio builders are doing”.

Capital Group will look to turbocharge this transformation with the launch of eight all-active ETF portfolios ranging from Global Growth to Conservative Income.

They will employ a mixture of Capital’s 22 ETFs, which have combined assets of $53bn and are used by 35,000 financial advisers, the company claims.

The Californian company already has $62bn in its existing range of model portfolios, which consist of vehicles that use a combination of Capital Group’s active mutual funds and ETFs, or alternatively combine Capital’s active funds with passive ETFs from the likes of Vanguard, BlackRock and Schwab.

Using ETFs rather than mutual funds can cut costs, given that ETFs typically have lower fees, as well as increase tax efficiency — the US tax system allows ETFs to dodge the bulk of the capital gains tax incurred by mutual funds.   

“ETFs have grown in their importance, in particular for taxable accounts,” said Holly Framsted, head of product group at Capital.

Framsted said the idea of launching all-active ETF models was the “number one question we have received since bringing ETFs to the market” in 2022.

“The entire ecosystem for financial advice is shifting. [Advisers] are getting paid by their clients for things like financial planning and whole-life advice, in addition to investment management. To make space for that, we are increasingly seeing them outsource their investment management to managers like Capital,” said Framsted, adding that the asset manager would probably launch more ETFs this year.

“Model portfolios are evolving to incorporate more flavours, like mixing active and passive ETFs, mutual funds and ETFs, single issuer or open source,” Armour said. “Capital Group appears to be adding their own iteration to these developments.”

The $2tn US model portfolio market is dominated by broker-dealers such as Edward Jones Investments, Merrill Lynch, Morgan Stanley, JPMorgan and LPL Financial, which have long sold their own proprietary models via their networks of advisers.

However, while these broker-dealers still controlled 75 per cent of the market, their dominance was starting to be eroded by the rise of portfolios operated by asset managers and other third-party providers, which were seizing all of the net inflows, said Matt Apkarian, associate director, product development at Cerulli Associates, a consultancy.

The largest five providers of these asset manager or third-party models — BlackRock, Wilshire, Capital Group, Vanguard and Russell Investments —controlled half of this between them, some $257bn, Apkarian said.

“Advisers increasingly have a preference for asset management models. There are more models available and advisers have manager preferences,” he added.

A Cerulli report published last summer found that 50 per cent of the US asset managers that did not currently offer ETFs would do so within the next 12 months, the overwhelming majority of which would be actively managed.