Non-transparent, Semi-transparent and Transparent ETFs

What Active Investment Advisers Should Know

>Non-transparent, Semi-transparent and Transparent ETFs

Non-transparent, Semi-transparent and Transparent ETFs

By | 2020-07-28T11:43:25-04:00 July 28, 2020|Exchange-Traded Funds, Registered Funds|

Authored by Alma Piscitello, EVP Relationship Management and Larie Lydick, VP ETF & Mutual Fund Services

Exchange-traded funds, or ETFs, are generally known for their low costs, tax efficiency potential, security-like trading and transparency. It is the transparent aspect of ETFs that has long been a deterrent to traditional active managers.

ETF Choices for Active Managers

Semi-transparent and non-transparent ETFs have become the buzz words for active managers. These not-fully transparent ETFs are intended to benefit the investment adviser by shielding proprietary portfolio composition from public view, and benefit the investor by providing access to active strategies at a lower cost with better tax efficiency potential.

Confusion abounds when talking about semi-transparent and non-transparent ETFs because, in practice, the distinction is unclear. For the sake of simplicity, the remainder of this blog will refer to ETFs that are not fully transparent as non-transparent.

The Fast and Furious Growth of ETFs

Today, there are over 2,000 ETFs in the U.S. representing combined assets of $4.23 trillion, an increase of 14% in assets from the prior year1 (as of May 2020). Ultimus, a fund administrator with nearly $3 billion in ETF funds under administration, has experienced the growth firsthand: with growth of new ETFs launched in excess of $2 billion in AUA over the past three years.

Are Fully Transparent ETFs a Deal-breaker for Active Managers?

The data suggests otherwise.

According to data by NYSE, there have been 61 active ETF launches and 73 passive ETF launches year-to-date in the U.S. (through July 10, 2020). Of the 61 active ETFs, 90% are fully transparent2.

With the SEC’s exemptive relief, described below, fully transparent active ETFs may become even more attractive.

Relief and More Relief from the SEC

Until recently, all ETFs had to apply for the SEC’s approval for exemptive relief under the Investment Company Act of 1940. This was time-consuming and costly. Recently, the SEC has made launching ETFs faster and cheaper.

  • Transparent ETF exemptive relief. In September 2019, the SEC voted to adopt Rule 6c-11, which permitted ETFs that met certain criteria to come directly to market without the cost and delay of obtaining an exemptive order.
  • Non-transparent active ETF exemptive relief. The SEC also approved exemptive relief for non-transparent active ETFs for specific providers, including ActiveShares (Precidian), Blue Tractor, NYSE, T. Rowe Price, Fidelity, and Natixis Investment Manager. ActiveShares, Blue Tractor and NYSE license their ETF “wrapper” structures to investment managers, allowing managers to launch active non-transparent ETFs more quickly.

“Wait and See”

As noted earlier, active investment managers commonly opt for fully transparent ETFs. It seems that active managers considering non-transparent ETFs may be taking a “wait and see” approach. What will be the adoption rate and success of these ETFs? Will performance be compromised? Will it be more difficult to manage the portfolio? Will it compromise the cost effectiveness of ETFs?

Fund Administration for Non-transparent Active ETFs Depends on the Licensing Entity

For active investment managers interested in the non-transparent ETF model, fund administration considerations are distinct from investment and trading considerations.

  • Trust’s Board approval. The investment adviser must receive approval for the licensed ETF wrapper arrangement from the Trust’s Board. Fund administrators such as Ultimus have been seeking approval from its sponsored Series Trusts in preparation for potential launches of non-transparent active ETFs.
  • Fund administrator. Not all fund administrators are equally versed and prepared to service ETFs. When selecting an administration partner to assist with the launch of an ETF or to service an existing ETF be sure they have experience, knowledgeable resources, established industry partnerships and provide counsel on distribution strategies.
  • Licensing. The licensing entities such as Blue Tractor, NYSE and ActiveShares have distinct solutions for implementing non-transparent ETF wrappers: proxy portfolios, shielded weightings and full non-transparency. These varying solutions affect data and formatting, and bring differing implementation methods.
  • Distribution partners. Distribution platforms face similar issues addressing the disparate data from non-transparent ETFs. There will likely be additional requirements from platforms regarding their pricing and programs for non-transparent ETFs in due time.

Non-transparent, Semi-transparent and Transparent ETFs: What is Apparent?

There is no right answer for active investment advisers looking to launch an ETF. Transparent ETFs have benefits. Non-transparent ETFs have benefits. Both may have drawbacks, too.

What is apparent is that the new non-transparent ETFs will benefit both the investment advisers that were bypassed by investors for ETFs, and ultimately the investors who can access more active strategies at a lower cost, with better tax efficiency and potential performance gains.

¹https://www.ici.org/research/stats/etf/etfs_05_20
² Data provided by NYSE 7/15/2020

2246-NLD-7/13/2020  8391 UFS 7/13/2020

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