Non-Transparent Active ETFs are not a Slam-Dunk
September 26th 2013 at 2:20pm by Tom Lydon
Exchange traded funds are known for their liquidity, low costs, tax efficiency and transparency. T. Rowe Price is looking into the space and seems to like everything ETFs have to offer, except the transparency part.
Although several traditional mutual-fund managers are working on non-transparent active ETFs, it’s not at all clear whether the SEC will allow these products to launch. ETFs need “exemptive relief” from regulators before they begin trading.
T. Rowe Price is seeking regulatory approval with the SEC to launch actively managed ETFs that do not disclose portfolio holdings daily, reports Jackie Noblett for Ignites.
“For a firm as large and ‘traditional’ as T. Rowe to stand behind the movement for non-transparent, actively managed ETFs is a big deal, to be sure,” Robert Goldsborough, ETF analyst at Morningstar, said in the article.
For fund firms, the allure of non-transparent ETFs is that the portfolio managers would be able to keep their trades a better secret. The theory is this would prevent front-running. But again, these non-transparent ETFs need to pass muster at the SEC, and that could be extremely tricky. Even getting plain-vanilla index ETFs through the regulatory approval process involves a lot of time and legal fees.
Eaton Vance also filed for exemptive relief to offer a non-transparent active exchange traded product called the exchange traded managed fund, or ETMF. BlackRock, State Street Global Advisors and Vanguard also have plans for non-transparent active ETFs. [Eaton Vance’s New ETF Structure Could be a Game Changer]
Daily transparency helps ETF market makers create or redeem ETF shares for baskets of underlying securities. T. Rowe believes its new non-transparent structure could compensate market makers through a “high-quality pricing signal” and “high-quality hedging vehicle” to properly arbitrage the products.
T. Rowe could craft two active ETFs based on its Capital Opportunities Fund and Blue Chip Growth Fund, but the filing would allow the firm to launch others as well.
“We see non-transparent active ETFs as an alternative vehicle for potentially delivering our investment management expertise to investors, without the prospect of daily disclosures impacting our existing mutual fund shareholders, consistent with their best interests,” T. Rowe spokesman Bill Benintende said in the article.
Transparency has been a sticking point among actively managed mutual fund providers, especially in equity portfolios. Active equity portfolio managers are more wary about potential front running due to daily disclosures. In fixed-income portfolios, transparency is not as demanding since it is very difficult to trade ahead of an institutional investor in the credit market and the portfolios hold thousands of individual securities.
The PIMCO Total Return ETF (NYSEArca: BOND) has been a successful active bond fund adaptation that has helped propelled interest among mutual fund providers looking into the ETF space.
Larry Petrone, director of research at kasina, argues that T. Rowe’s offerings would only stand a chance if clients demand the same strategies but in the more efficient ETF investment structure. However, he points out that while the ETF structure is cheaper, the new arbitrage mechanism could push up costs.
“The only reason I could see right now is if firms are convinced the end client is demanding the ETF format because of the expectation of lower fees,” Petrone said in the article.
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Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.