- In May, the SEC gave the green light to a new kind of exchange-traded fund. Unlike traditional ETFs, the so-called "non-transparent active ETF" is managed much like a mutual fund instead of being tied to an index like the S&P 500, and the portfolio manager doesn’t have to disclose what’s in the fund daily.
- Now, asset managers are rushing to the space, with more than 30 firms getting ready for their own ETFs.
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Some of the asset managers that have long scorned exchange-traded funds are finally looking at entering the space after the SEC approved a new structure that gives them more control — and more revenue.
Active managers have been hemorrhaging money for years. In 2018, US investors pulled a near-record $301 billion from active funds, per Morningstar, while lower-fee and more tax-efficient passive funds collected $458 billion.
Despite the outflows, many managers have stayed away from passive funds. They view the "race to the bottom" – a push to lower fees that culminated with an ETF that will pay investors – as detrimental to their core business of higher-revenue mutual funds. Many have also been averse to creating funds that reveal their trade secrets, since ETFs publish their holdings daily, whereas mutual funds report theirs quarterly.
In April, the SEC approved a new structure – the "non-transparent active ETF" — from Precidian Investments, which tries to do away with those issues. Precidian’s version of the new wrapper is called ActiveShares, which can now be licensed by asset managers. The structure allows managers to create ETFs run by portfolio managers, rather than funds tied to indices. Those ETFs then report holdings quarterly, instead of daily.
Managers are hoping these new ETFs can serve as a middle ground between passive ETFs and active mutual funds. It’s a last-ditch effort to woo investors back to firms that have lost billions from the move toward passive investing, and that are now struggling with falling margins.
The non-transparent active ETFs could, in theory, generate higher returns than their index-tied passive peers, because of their ability to trade more independently. The decline of idiosyncratic, company-specific moves has been a long-standing criticism of passive stock indexing.
ETFs also offer better tax benefits than mutual funds. While more than 30 managers are now creating – or at least thinking about – ActiveShares ETFs, it’s not yet clear what the consumer demand will be.
Investors haven’t flocked to similar active ETF products as they have to passive strategies, though they’re gaining ground. Active ETFs had $77.5 billion as of May 31, per Morningstar, compared with $3.6 trillion for passive ETFs. Despite huge outflows, actively-managed mutual funds still command the lion’s share of capital: $11 trillion.
‘You’d probably guess the money would flow there’
When ActiveShares was approved, Precidian already had 10 managers lined up to license the product, including BlackRock, JPMorgan, Capital Group, and Nuveen. Since then, the firm inked another 24 contracts "with many of the largest asset managers out there." Precidian is minority-owned by Legg Mason.
Precidian CEO Daniel McCabe told Business Insider that some of those managers are creating near-replicas of their existing mutual funds, translating the strategy to ETF form, while others are mulling a total conversion from mutual fund to ETF.
"If that’s available, I think you could see them get scaled very rapidly," McCabe said. "I find it somewhat comical that people would think there’s no demand for this when you look at the demand for active management in a mutual fund wrapper."
He continued: "If I can offer you similar exposure in a more cost-effective vehicle, you’d probably guess the money would flow there. There are multiple trillions in these products."
Giang Bui, CBOE’s director of listings, said there’s plenty of room for the nontransparent active ETFs alongside current products.
"We think these will be the next-generation mutual funds and this is the way for ETFs to close the gap with mutual funds," she said at a New York ETF conference earlier this month.
Cerulli Associates, a Boston-based consultancy, surveyed product heads at the largest asset managers before the SEC approved ActiveShares and found that about half were interested in launching a non-transparent active ETF strategy, preferably within a year. More than half would launch an equity fund, while 30% would think about fixed income.
"One of the mega-trends in the industry is to provide products in a wrapper-agnostic manner," said Daniil Shapiro, an assistant director in the firm’s product development practice. "One of the challenges we think issuers of these products may face is they may be unwilling to significantly discount their products, which in turn would make them unattractive."
Because only two managers – American Century Investments and Gabelli – have filed to launch these new ETFs, it’s too early to know what the typical fees will be. McCabe declined to comment on how his clients are structuring their ETFs.
"I don’t think they feel they need to compete with the passive products that are running to zero," he said. "If you’re spending a lot of time and energy creating intellectual property … people are willing to pay for that."
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‘The demand is truly unknown’
Another open question is investor demand. Ed Rosenberg, the head of ETFs at American Century Investments, said some advisors have said they’ll likely switch from mutual funds to the active non-transparent ETF. Others said they’ll add it to their existing product line-up, while a third group said they’re still unsure if they’ll use it or not.
"I think the demand is truly unknown because it doesn’t exist today," Rosenberg said. "Once it’s live, then you get to make a decision."
Eric Pollackov, Invesco’s head of ETF capital markets, said that while his firm hasn’t filed for an active non-transparent ETF, they’re monitoring Precidian’s model and similar efforts from other firms.
"The advisors have not been on the sidelines asking for these products, which tempers our view of demand for them," Cerulli’s Shapiro said. "On the other side, if these products trade like an ETF, the question isn’t for the advisor … it’s almost a question for the gatekeepers and the platforms that will have to evaluate these products. It’s up to them to decide if they want these products on their platforms."
In a late May research note, UBS analysts likewise noted wirehouses’ ambivalent stance on the products. The analysts also said BlackRock is monitoring other products’ performance and customer uptake as the $6.5 trillion firm decides which of its active products could be launched in the new format.
Armando Senra, BlackRock’s Americas head of iShares, told Business Insider that investors should be cautious of managers pursuing new forms of old products.
"An underperforming manager that’s wrapping an ETF doesn’t create well-performing products," Senra said. "These new technologies for ETFs aren’t going to solve the problem of performance. It’s a powerful wrapper and we’re looking at ways in which active management will use it."
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