Question marks hover over non-transparent ETFs

The new type of ETFs has massive potential for active managers, but there are still hurdles to its adoption

Question marks hover over non-transparent ETFs

The underperformance of active funds in comparison to passive products, including ETFs, has been well documented and reported. One way to narrow the gap is to create active strategies in an ETF format, and with the recent regulatory approval granted to a line of non-transparent ETFs from US-based Precidian Investments, more active managers could be willing to take that path — though some hurdles still remain.

“For the first time, investors will be able to access actively managed ETFs that do not disclose their holdings on a daily basis, but trade and operate in a similar manner to other ETFs,” said Dan McCabe, CEO of Precidian, shortly after the approval of his firm’s non-transparent ActiveShares line.

It must be noted, however, that active ETFs in Canada have long benefited from the lack of a requirement for daily disclosure. Because such ETFs are treated the same as mutual funds, their managers only have to provide quarterly disclosure of their top 25 holdings, and semi-annual disclosure of their entire portfolio within 60 days of the end of the period.

With the US approval of Precidian’s ETF strategy, there’s a wider opportunity for active ETFs that don’t give away their holdings, effectively allaying widely held fears that fund strategies could be reverse-engineered or that specific trades might be front-run. A host of fund companies south of the border have already licensed ActiveShares from Precidian, including BlackRock, J.P. Morgan, and Nuveen.

“[W]ith lower costs and without the tax drag, perhaps active managers can close the performance gap or even … generate more consistent outperformance,” said Nate Geraci in a column published on

But even with that potential advantage, Geraci said, active managers’ adoption of non-transparent ETFs isn’t a sure thing. One potential concern is the potential harm they’d inflict on their other products, particularly their mutual fund cash cows that will in all likelihood be more costly. Coming out with non-transparent ETFs could be seen as a tacit admission of mutual funds’ inferiority in comparison to ETFs.

Performance is also a crucial question. Adopting a non-transparent ETF structure would certainly help active stock fund managers with their underperformance problem, particularly as it would defray costs from fees and taxes. But Geraci noted that unless the new fund strategies can consistently outperform the market to the point that it clears the remaining fee hurdle relative to passive products, their success is still questionable.

He also pointed to the existential threat that smart-beta ETFs represent for active managers. With such strategies offering the automation of active management through a rules-based, algorithmic approach, he said they should at least represent an obstacle for stock-pickers.

Finally, Geraci noted that ActiveShares’ non-transparent ETF structure involves the use of a “trusted agent” who sits between authorized participants (APs) and the ETF sponsor. With trusted agents performing functions such as creations and redemptions on behalf of APs using confidential accounts, there’s an additional layer of complexity that creates more room for error.

“Concerns have been voiced over bid/ask spreads … given that APs won’t know the exact underlying holdings,” Geraci said. “Concerns have also been raised regarding insider trading (which the SEC has rebuffed). AP representatives will be under contractual obligation to not disclose holdings.”


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