Non-transparent ETFs pass their first test — spreads are tight
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A new breed of ETFs approved by the Securities and Exchange Commission last year have passed their first test — spreads are surprisingly tight, which is keeping costs down.
The spreads between the price to buy and sell shares on the new vehicles have been “relatively tight, given what we might have expected”, said Elisabeth Kashner, director of ETF research at FactSet.
Of the 12 non-transparent ETFs currently on the market, nine were at or below the median spread in their asset category, according to FactSet data measured over the 45 days ended September 3. The new “shielded” ETFs are mainly focused on large and mid-cap equity strategies.
The SEC approved the formation of so-called active non-transparent ETFs in 2019, giving the green light to a vehicle that allows managers to keep their precise holdings hidden, preventing other participants from being able to frontrun their trades. Traditional ETFs, even if actively managed, publish their holdings daily.
Larger spreads drive up the costs of trading ETFs and industry observers had been concerned that market makers, who provide liquidity by buying large quantities of ETF shares, would be more cautious with the new breed of ETFs, which would widen spreads, Ms Kashner said.
The ETF market is growing in importance, Ms Kashner said. So far this year US investors have pulled $299bn from mutual funds while adding $241bn to exchange traded vehicles, data from Morningstar Direct shows.
“For old line asset managers, especially, who sat out the early years of the ETF revolution, it’s a pretty critical business strategy for them to make the leap into the ETF world,” Ms Kashner said.
Managers that are planning to enter the ETF game for the first time include Fred Alger Management, which recently announced plans to launch two non-transparent products. It had been considering launching ETFs since the 1990s, said head of distribution Jim Tambone, but had been put off because traditional ETFs require firms to publish details on their trading strategies.
“The market would see how you’re trading those portfolios,” Mr Tambone said. “That’s just not something any active manager wants to have happen.”
Non-transparent products launched this year by American Century, Fidelity and ClearBridge had a combined total of $374m in assets as of July 31, according to Morningstar data. Another four from T Rowe Price, the company’s first-ever ETFs, launched in August.
The bulk of those assets in the new breed of ETFs — $317m at the end of July — are in American Century’s four ETFs.
“It seems that there was a pent-up demand for active,” said Ed Rosenberg, American Century’s head of ETFs.
Demand for active funds grew after market volatility this year “reminded people that indices can go up and down”, said Anthony Disanzo, senior consultant at ISS Market Intelligence. This year marks the first time that active ETF launches, including transparent products, outpaced new passive funds in the US.
The non-transparent ETFs are not being offered yet by the large broker-dealers and their thousands of advisers, as those platforms require funds to have longer track records, typically three years.
As with any new vehicles, clients will take time to adopt the product, said Tim Coyne, head of ETFs at T Rowe Price.
“We’re looking at this as a marathon, we don’t see this as a sprint,” he said.
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