SEC OKs a Nontransparent Active ETF Strategy, but Will Investors Care?

The SEC has just given tentative approval for the first nontransparent actively managed ETF strategy, which could potentially upend the fund industry.

The agency approved an application by Precidian Investments to license ActiveShares, an ETF structure that will disclose daily holdings only to an unaffiliated representative of the authorized participants who are key to the creation and redemption mechanism that keeps ETF share prices aligned with their underlying net asset value. ActiveShares will not disclose holdings on a daily basis as traditional ETFs do, but quarterly with a 60-day lag as mutual funds do.

The SEC will grant final approval of the Precidian application unless it orders a hearing, which can be requested on or before May 3.

"Assuming the formal approval comes through, this will open the floodgates for multiple funds to launch that license the Precidian structure," said Matt Hougan, chairman of Inside ETFs and global head of research at Bitwise Asset Management. "This is yet another nail in the coffin of mutual funds. They had a good run, but their heyday is in the past. ETFs are clearly the future."

But many firms best known for their mutual funds — some with ETFs too — have already licensed ActiveShares from Precidian and will presumably offer nontransparent ETFs, including Legg Mason, Capital Group, JPMorgan, Nationwide, Gabelli, Columbia, American Century and Nuveen.

"We could soon see ETF versions of successful actively managed equity strategies from these firms," writes Todd Rosenbluth, head of ETF and mutual fund research at CFRA. "Precidian-based products could be successful in generating assets, though we see risk of cannibalization of some of a firm's existing mutual fund base."

Ben Johnson, director of global ETF research at Morningstar, sees the Precidian products as providing "asset managers another means of packaging and delivering strategies, which helps to level the playing field for mutual funds," but he questions whether there is much demand from investors. "I'm not entirely sold on this as a meaningful improvement versus fully transparent ETFs," he said.

Indeed, investors have been souring on actively managed funds in favor of passive index investments, whether they be mutual funds or ETFs. In 2018 they invested a net $207 billion in passive U.S. equity funds and withdrew $174 billion from active U.S. equity funds, according to Morningstar, whose data includes both mutual funds and ETFs.

Johnson and others note that fund companies want the ability to trade nontransparent ETFs to protect the "secret sauce" of their active management, though there is skepticism about how successful that ingredient has been given the underperformance of active funds in general over time compared to their benchmarks.

Dave Nadig, managing director of ETF.com, like Johnson is not sure about investors' demand for nontransparent actively managed ETFs.

"For investors, really, unless you're clamoring for a specific active manager in an ETF shell, it's hard to see the demand. These products will be 'sold' not 'bought' — in the sense that I doubt anyone is going to just 'discover' a new active non transparent equity fund like they might, say, a cheap Schwab ETF offering vanilla beta exposure. I expect a lot of marketing dollars will be spent."

Hougan, too, is uncertain about investor demand overall but notes that "the demonstrable truth is that some investors want exposure to active and some fund managers are concerned about transparency, and this structure will allow those investors to gain the exposure they want in a fairer, lower-cost and more efficient structure."

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SEC OKs a Nontransparent Active ETF Strategy, but Will Investors Care?

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