ETF

Non-transparent ETFs: What you should know!!!

Has the saviour of active management finally arrive? Will the non-transparent aspect of an ETF help active management to finally beat the market consistently?

Unlike most ETFs that reveal their holdings daily, with some reveals every month (cough cough Vanguard), a new ETF fund structure which got approved by the US SEC, called the ActiveShares, allows the ETFs’ holdings to be kept confidential. ActiveShares is created by Precidian Investments.

https://www.cnbc.com/2019/06/15/the-first-non-transparent-etf-gets-sec-approval-heres-how-it-works.html

Who will benefit from ActiveShares?

In short, active fund managers who want the stealth aspect of mutual funds holdings and the benefits of operating ETFs.

Key Benefits of ActiveShares

Front-running & free-riding

The non-transparent aspect of the ActiveShares ETF structure means that it protects the intellectual property of the active fund managers. In other words, since the holdings are confidential, the fund managers do not have to worry about someone front-running or free-riding their portfolio decision.

Tax efficiency & intraday liquidity

All the benefits of operating an ETF applies to non-transparent ETFs as well, such as tax efficiency and liquidity. Currently, regular ETFs quote their NAV to the market every 15 seconds. Funds with ActiveShares ETF structure will publish a verified intraday indicative value every second.

For the creation and redemption process to take place, authorized participants (APs) of ActiveShares ETFs will be provided data on the ETFs’ holdings and use confidential accounts to facilitate the creation and redemption process.

For more information on the tax efficiency of an ETF, see: ‘Heartbeat Trades’ & ETFs: The elusive world of tax optimisation

For more information on what goes on during the creation and redemption process, see: The creation and redemption mechanism of ETFs!

Lower costs

The efficiency of operating an ETF will mean that the fund issuers can lower the total expense ratio (TER) of the funds. For retail investors that want exposure to active management, this will present a more attractive value proposition as compared to active mutual funds.

Will it help active managers?

To some extent, yes.

All the operational benefits of operating an ETF applies to a non-transparent ETF as well, which means that they can start on a level playing field with their passive counterparts. While it will be quite some time before we see a single-digit TER for a true actively managed fund, the ActiveShares ETF structure is definitely pointing to the direction of lower TER in the future.

What does it mean for you?

While smart-beta ETFs represent an alternative solution for active fund management, technically it is not a true actively managed fund in the sense that the fund managers of smart-beta ETFs do not have the full discretionary to select the securities that go into the ETFs.

For more information on smart-beta ETFs, see: Should smart-beta ETFs have a spot in your investment portfolio?

A true actively managed fund means that the fund manager has the full discretionary to select the securities that go into the fund. A true actively managed fund is more expensive to manage.

With a more efficient fund structure, this will lower the operating cost of a true actively managed fund and makes it more accessible to the masses.

If you as a retail investor is looking for a true actively managed fund and is repulsed by the expense ratio of active mutual funds, fund houses that package their active strategies into Precidian’s ActiveShares ETF structure will present you with an attractive value proposition in the form of lower TER.

Will non-transparent ETFs takeoff and be a major success similar to their passive counterparts?

Potentially, no.

The 08/09 financial crisis had created a bad memory on many peoples’ mind and the thought of a non-transparent financial vehicle can be a repulsive factor for many people.

Will active managers be able to beat the market then?

We know that most active mutual funds underperformed their benchmarks.

With this new fund structure, i.e. Precidian’s ActiveShares or non-transparent ETFs, for active funds, we can’t tell for sure since there is no record long enough for us to compare the performance of ETFs using the non-transparent structure, against their benchmarks. However, if active funds have to rely on their fund structure instead of their active strategies which are the core of active fund management, to beat the market, what does it say about their active strategies?

I guess every little bit of advantage help the active funds, right?

Vanguard Active Funds Performance

The above diagram is not a true representation of all active ETFs’ performance as a whole. Instead, what I am trying to convey is that if transparent ETFs already have a hard time beating the ‘holy’ S&P 500 with some lagging the S&P 500 by a serious margin, what makes you think that a non-transparent ETF will make any difference?

For more information on active fund managers’ performance, see: SPIVA: Doomsday for active fund managers?

Bottomline

What happens when a closet-indexer uses Precidian’s ActiveShares structure to hide their holdings?

I believe it is the active fund managers that trigger the demand for non-transparent ETFs, not the investors. Is the secret sauce really worth protecting considering that most active managers fail to beat the market consistently? In the first place, would you as a retail investor even want it?

You decide.

As always, take personal responsibility of your financial well-being and do your own due diligence.

 

 

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Disclaimer: This article does not constitute a solicitation to buy/sell any securities that may be mentioned in this article. At the time of writing and publication, the author does not hold any position in any of the securities mentioned in this article. I am writing in my personal capacity and my views do not represent that of any organisations.

 

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