July 17, 220
Actively managed exchange-traded funds have been the biggest story that never quite happened every year for more than a decade. But thanks to the approval of a new kind of ETF, that’s starting to change. A flurry of launches from American Century, Legg Mason, and Fidelity Investments—and lots more in the works from T. Rowe Price, BlackRock, and Dimensional Fund Advisors—means 2020 is shaping up as the year in which active takes off.
Make no mistake, there are some 400 actively managed ETFs out there. But few can be called a success: They account for less than 3% of the $4 trillion ETF industry, and nearly a quarter of their assets are in just two of them.
The hangup was that fund companies were wary of the transparency inherent in the ETF structure: Any investor could see what, and how much of it, a fund owned at a given moment. The turning point came in 2019, when the Securities and Exchange Commission finally approved five new ETF structures that allow less frequent disclosure of a portfolio’s holdings.
Since then, many asset managers have partnered with one of those approved structures—offered by Precidian Investments, the New York Stock Exchange, Blue Tractor, Fidelity, and T. Rowe Price (ticker: TROW)—to develop their own active ETFs. “The industry has been waiting for the technologies and the approvals by the SEC to really kick off the equity side of the ETF story,” says Greg Friedman, Fidelity’s head of ETF management and strategy.
The five structures allow varying degrees of transparency; companies can use different structures for different funds. A concentrated fund, for instance, might be better suited to a more shielded structure.
Thanks to SEC approvals last year, active ETFs can now disclose holdings less frequently.
Note: Mutual fund tickers represent the fund’s oldest share class; expense ratios represent the range among all share classes; year-to-date returns represents total returns for the oldest share class through July 15
Sources: Morningstar; company reports
The first model approved, Precidian’s ActiveShares, requires ETFs to disclose holdings quarterly, similar to a mutual fund. Legg Mason (LM), which owns 20% of Precidian, American Century, BlackRock (BLK), Goldman Sachs (GS), JPMorgan Chase (JPM), and 10 other firms have partnered with Precidian to launch products using its model. American Century’s and Legg Mason’s are already trading.
Fidelity’s model requires ETFs to reveal a proxy basket every day. Its holdings overlap—but aren’t identical—to the actual portfolio. The company rolled out three such active funds last month, and has licensed the structure to Invesco (IVZ) and Goldman.
T. Rowe Price and NYSE’s models resemble Fidelity’s. T. Rowe Price’s first-ever exchange-traded funds should debut in the third quarter. The NYSE has partnered with Natixis Investment Managers, Nottingham, and American Century. The latter just launched two active ETFs using its structure, and focused on environmental, social, and corporate governance, or ESG, factors.
Blue Tractor’s Shielded Alpha is the most transparent of the five. It discloses all holdings in an ETF, but not how much is in each holding. The firm is focused on partnerships with smaller ETF providers, such as Nottingham, Tidal ETF Services, and Toroso Asset Management.
Even full transparency in active strategies seems to have become more acceptable for fund companies. In 2020’s first half, over 35 fully transparent active stock ETFs, which disclose holdings every day, were launched. That’s more than in all of 2019. Soon to arrive are three each from BlackRock and Dimensional. “We have thousands of holdings in our portfolios,” says Dimensional co-CEO Dave Butler. “We’re confident that’s not going to be problematic for us in terms of having a transparent approach to the ETF.”
For now, most active ETFs are more or less clones of existing funds, with the same investment philosophy and the same management teams. The holdings won’t be identical, however, since ETFs have more limitations on what they can own and must pay more attention to liquidity. Legg Mason’s ClearBridge Focus Value (CFCV) will own fewer stocks than its sister mutual fund, ClearBridge Large Cap Value (SAIFX), for example.
The ETF wrapper can help overcome the biggest hurdle to active management—cost—by making the same portfolios cheaper and more tax-efficient. And they can be available on more platforms, often at lower trading costs. “My guess, if I were to look into a crystal ball, would be that the balance of the fund industry is going to move from the open-end [mutual funds] to ETFs in the next 10 years,” says Nottingham CEO Kip Meadows.
But mutual funds have a big advantage: They allow buying and selling of fractional shares, a necessity for inclusion in 401(k) and other automatic investment plans. Besides, ETFs’ intraday trading might not matter much to long-term investors, and their tax benefits aren’t as important in tax-advantaged plans.
Fund companies say they aren’t worried about cannibalism. Tim Coyne, head of ETFs at T. Rowe Price, says they offer an additional choice to access the firm’s strategies. And Fidelity’s Friedman says, “The clients that use mutual funds are different from the clients that use ETFs.”
Ultimately, whether active exchange-traded funds gain traction depends on performance. “The [ETF] wrapper is a good wrapper, but you still need the five-star managers,” says John Mulroy, director of capital markets at Blue Tractor. “The wrapper can’t change the dog fund manager into a superstar.”
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