Five years after the SEC approved non-transparent, actively managed ETFs, the vehicles have struggled to gain traction. Their opacity and lack of differentiation from transparent, actively managed ETFs has left investors unenthusiastic, industry insiders say.
Unlike regular ETFs, non-transparent, actively managed ETFs do not have to report their holdings daily. Instead, these funds file monthly or quarterly reports, functioning more like mutual funds. Of the 70 such ETFs launched since 2016, only 50 remained in the market by February 2024, according to a report published last week by investment research provider Morningstar. Together, they hold $5.2 billion in assets, less than 1% of the $530 billion in assets under management for all actively managed ETFs in the United States. That's even as several well-known asset managers, including Fidelity, Nuveen and T. Rowe Price, jumped into the market and launched products.
Limited transparency can be a boon to asset managers, allowing them to protect the secrets of their investment strategy, noted Bryan Armour, director of passive strategies research, North America, with Morningstar. However, “I don't think it's something that helps investors at all. The problem is that they require complex processes to operate.”
In addition to reporting their holdings less frequently than regular ETFs, non-transparent ETFs don't have a standardized method for reporting what they hold in their portfolios, Armor noted. The SEC adopted several different methodologies for how these vehicles can report, ranging from a NAV figure plus or minus a penny to using proxy stocks that are similar in price to, but not the same as, the non-transparent ETF's actual holdings. . These complicated frameworks tend to confuse investors, and many of them decided to stay away, according to Armour.
Meanwhile, because SEC regulations restrict non-transparent active ETFs from investing in US exchange-traded securities, they cannot benefit from the active management strategies that are more likely to yield large returns. , said Lara Crigger, managing editor at financial consulting firm VettaFi. She noted that active management tends to add the most value in markets or asset classes where price discovery or access is difficult for the average investor. The SEC's guidelines for non-transparent ETFs “remove many tools from the toolbox for active managers. What they're left with are U.S. equity securities that probably aren't providing enough differentiation for investors beyond what they can already find in the market.”
Savvy investors want to understand exactly what they're putting their money toward, according to Steve O. Oniya, chief investment officer with Houston-based financial advisory firm OM Investments. “I and others are uncomfortable if we can't at least look at the top 10 holdings frequently to check how the fund is performing and being managed,” he wrote in an email. “Opacity also limits liability if you don't know or understand what you should be.”
Oniya added that his firm would be “cautiously open” to investing in non-transparent, actively managed ETFs if they disclosed their real assets on a limited schedule – for example, quarterly.
The extent to which a lack of transparency can affect inflows can be seen by looking at ETFs managed by T. Rowe Price, according to Crigger. T. Rowe Launches First Non-Transparent Actively Managed ETF, Blue Chip Growth ETF (TCHP), in 2020. Since then, the fund has amassed approximately $550 million in net assets. TCHP's NAV is up 2.08% in the past month, so “in terms of performance, it's doing very well,” Crigger said.
Otherwise, T. Rowe Equity Appreciation Equity Price ETF (TCAF), which launched last summer and invests in stocks benchmarked against the S&P 500, already has over $1.2 billion in net assets. TCAF reported NAV growth of 2.58% for the past month.
“I think you see very clearly that investors, when given the choice between two different types of T. Rowe Price active management strategies, are choosing the transparent version over the non-transparent version,” Crigger noted.
Lack of transparency may be keeping non-transparent ETF vehicles out of many model portfolios. VNRs may be reluctant to include them without understanding whether they would lead to overconcentration in particular stocks or sectors or how they would affect risk/return calculations. And inclusion in model portfolios can be crucial to the success of an ETFCrigger said.
“You have a single percentage inclusion in a model portfolio managed by BlackRock, and suddenly you have billions of dollars moving into that ETF. It makes a big difference.”