The non-transparent ETF structure continues to gain traction among active ETF managers who value the confidential nature of these investments.

Unlike typical ETFs, non-transparent ETF managers don’t have to disclose their fund’s investments every day. This preservation tactic helps to keep asset managers competitive by allowing them to differentiate their investment strategies and product offerings.

This could potentially mitigate outside risk/market bias, excess volatility and copycat funds while offering companies a new revenue stream via licensing rights. This foreshadows a potential wave of ETFs to come based on the structure.

Grant Engelbart, director of research and senior PM at CLS Investments, caught up with ETF Trends to share his insights on the non-transparent ETF space and potential impacts on the market and his outlook on the industry

ETF Trends: Where’s the demand for non-transparent ETFs coming from?

Grant Engelbart: Demand for non-transparent ETFs will likely be from traditional mutual fund users that are looking for a more tax-efficient vehicle than the traditional open-ended mutual fund. Big ETF users (like ourselves) will likely also be users as we understand the benefits of the ETF structure and how to appropriately utilize ETFs. I think that ETF strategists and model providers such as ourselves fit in between retail investors and institutional investors, and will likely be the largest users. It should also be noted that several of the larger firms that are interested in non-transparent ETFs have private wealth divisions that could essentially “bring their own assets” to help get these off the ground. Investors should demand non-transparent active ETFs from a tax standpoint alone.

ETF Trends: Will there be efforts to cater to institutional investors?

Grant Engelbart: There definitely should be. Typically institutional investors will access similar strategies in lower cost (or negotiated cost) wrappers such as SMAs. If non-transparent active ETFs can be cost-competitive with SMA offerings then institutional investors should be sought after. As mentioned, I do think thank one of the key markets for these products will be in the “in-between” space, realistically where CLS sits. We manage money on behalf of Advisors for their end clients, in addition to managing for some institutional clients. We know ETFs very well and their benefits, and would likely be users of active non-transparent ETFs from well-known managers that we have been familiar with in the mutual fund or SMA space.

ETF Trends: How these ETFs could fit into model portfolios?

Grant Engelbart: An active strategy can fit well as a complement to a low cost diversified core. Having a portion of your account in an inexpensive smart beta (or traditional beta) core position and then adding active strategies on the edges may make a lot of sense, depending on the investor’s desire for tracking error. We’ve also used and seen others use active strategies in less efficient or less covered areas of the market such as small-cap stocks, emerging markets, and parts of the fixed income market. As various products come to market, traditional mutual fund model portfolios could see these non-transparent active products replacing various funds in their models.

ETF Trends: What investors are best suited for this investment?

Grant Engelbart: We think that any investor suited for traditional mutual funds would be suited for a non-transparent active ETF (which in reality is most investors). With one big caveat – the ability to trade the non-transparent ETF appropriately, or ideally have someone else do that for you. As various proposals for non-transparent active are potentially approved, due diligence will be important to understand the nuances and be able to trade the products appropriately. In the end, however, we feel that as more active managers move to the ETF wrapper the cost and tax savings are huge benefits for investors.

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