The proposed launch of a new kind of non-transparent ETFs may prove to be a positive development among active managers, though the demand for such novel strategies is less clear.
A recent report by Cerulli Associates noted muted expectations for actively managed non-transparent ETFs, with just over half of ETF strategists polled saying they would not use the products in their portfolios. The key sticking point, as industry professionals and experts point out, revolves around the absence of clarity on a given fund’s holdings.
“There is a concern about the ability of market makers’ ability to quote accurate prices if they don’t have a clear picture,” Ben Johnson, director of global ETF research for Morningstar, told The Wall Street Journal.
The particular non-transparent ETF structure being proposed by Precidian Investments, whose application is being considered by the US Securities and Exchange Commission (SEC), provides information on holdings to market makers, but not to the general public. “We also provide updated intraday pricing every second, so the product behaves and should be treated like any other ETF,” said Precidian CEO Daniel McCabe.
Other proposed non-transparent ETFs use other methods to provide holdings data to market makers, though Johnson said it’s unclear how seamless the process will be. The complexity of the new structure also creates a learning curve for broker-dealers and financial advisors, to whom providers will have to extend a helping hand.
Jeremy Held, director of research at SS&C ALPS Advisors, added that the lack of transparency will have a lot of investors crossing their arms. They’ll have to be convinced that the delayed disclosure of holdings will produce or lead to a clear benefit — a tall order given the performance struggles of active funds as well as the existence of transparent active ETFs with established track records.
Held isn’t alone in his doubts. WisdomTree and Charles Schwab, in particular, have expressed misgivings about the new vehicles’ lack of transparency and potential performance concerns on recent earnings calls with reporters and analysts.
The case for non-transparent ETFs might be easier to make to a jury of mutual-fund investors, who are likely comfortable with a little opacity. But Nick Elward, senior vice president and head of ETFs at Natixis Investment Managers, warned that investors should closely examine the tax implications of a switch to non-transparent ETFs. The damage from a possible tax hit on mutual-fund investors who sell their shares, in particular, should be outweighed by other benefits.
“These products certainly give investors more choices for active management,” Elward said. “But it will be incumbent upon managers to prove the benefits and that they can outperform consistently.”
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