Nearly an exclusive venue for index-tracking products, the $4.24 trillion ETF market is on the verge of receiving actively managed products that hew closer to the disclosure regime for traditional mutual funds than the daily transparency required for nearly all ETFs.
An approval in May by the U.S. Securities and Exchange Commission for a novel ETF structure engineered by Precidian Investments LLC of Bedminster, N.J., was followed this month by regulatory notices of four additional structures for actively managed ETFs seeking relief from certain stipulations in the Investment Company Act of 1940.
Barring requests for public hearings by Dec. 9, products based on these structures by T. Rowe Price Associates Inc., Fidelity Management & Research Co., Blue Tractor Group LLC and Natixis Advisors LP could then move to apply for listing on a securities exchange.
Though skeptics abound, the heft of the names behind these new structures indicate that a significant market for active ETFs could be willed into existence.
Asset managers with announced licensing agreements with Precidian include Capital Group Cos., BlackRock Inc., J.P. Morgan Asset Management, Goldman Sachs Asset Management, Nuveen and Legg Mason Inc. (which owns a minority stake in Precidian).
"While a separately managed account may be cheaper on an expense-ratio basis than an ETF, setting up or winding down an SMA is still a process for the end investor," said Edward Rosenberg, senior vice president and head of exchange-traded funds at American Century Investments, also a Precidian licensee. "Whether for transition management or a long-term investment, an ETF, transparency aside, offers investors more control over their entry and exit points."
Potential fund fees have not yet been disclosed. Currently listed active equity ETFs, which disclose their full portfolios on a daily basis, have an average expense ratio of 0.67%, according to research firm XTF Inc., and fixed-income products average 0.50%.
Active ETFs currently comprise just 2.2% of the U.S. market, according to XTF through Nov. 15, and 76% of those assets are in fixed-income funds. By comparison, active products make up 59.6% of the total $19.4 trillion U.S. fund market as of Sept. 30, according to Morningstar Direct, and 31.6% of those assets are in fixed-income funds.
The scope of initial products, which for Precidian includes funds managed by Legg Mason subsidiaries Royce & Associates LP and ClearBridge Investments LLC, is limited to holdings of exchange-traded stocks, American depository receipts, real estate investment trusts, exchange-traded commodity pools and futures, other assets that trade "contemporaneously" on a listing exchange, and cash instruments, including short-term U.S. securities and money market funds. Leverage and short positions are not allowed.
The architects of these new structures have spent several years trying to back the existing efficiencies of ETFs into a solution that could still compel a "low-risk" trading arbitrage without fully disclosing the fund portfolio on a daily basis. Precidian relies on blind trusts to intermediate flows to and from the funds; whereas the more recent trove of noticed applications rely on a variety of daily-disclosed "proxy portfolios" to encourage creations and redemption activity.
The varying levels of purposeful obfuscation in these structures even have many ETF market observers debating what to call these products. (Active non-transparent ETFs, or ANTs?) But regardless the nomenclature, it's most likely that these products will just shift into consumer consciousness as actively managed ETFs, with debates about structures and transparency left to insiders and academics.
Karen Barr, president and CEO of the Washington-based Investment Adviser Association, said that her organization believes that "active ETFs could level the playing field on the tax advantage issue."
While indexed products are generally tax-efficient due to limited turnover compelled by the index itself, ETFs (including existing active funds) benefit from in-kind creations and redemptions for investment flows, allowing the fund to more efficiently manage its tax basis and reduce potential capital gains distributions.
Tim McCusker, chief investment officer for Boston-based NEPC LLC, which advises on roughly $1.1 trillion controlled by institutional investors, said his firm has fielded few "questions or interest from clients to date" on active ETFs generally.
"I've looked at some of these products over the last few years," Mr. McCusker said. "I don't know if they can offer anything that other pooled structures do not, and I don't think there is a desire or need for a vehicle that can be traded through a trading day. But, some of these structures have offered the benefit of lower operating costs and that is very interesting."
