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Dec. 11, 2019, 1:47 p.m. EST

What is a ‘non-transparent’ ETF, and why would anyone want to own one?

‘I don’t know that opaqueness has ever benefited anyone,’ says one adviser

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By Andrea Riquier


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“Actively-managed non-transparent ETFs” are a mouthful to describe, have taken over a decade to develop and now, thanks to regulatory approvals secured this week, they will soon be widely available to investors.

Exchange-traded funds, which have been around for nearly three decades, have a few selling points. They allow broad, diversified access to investing themes, like mutual funds, but with much more accessible trading, like stocks. While mutual funds disclose their portfolios only once a quarter, ETF holdings can be seen every day, allowing for real-time pricing and tradeability.

That’s all made ETFs wildly popular for “passive” investing, but has kept most active managers tethered to the mutual fund structure. The new non-transparent ETFs try to offer a happy medium: they allow active managers to mask their strategies,while keeping the pricing of the fund liquid enough that it can be traded throughout the day.

On Thursday, the Securities and Exchange Commission gave its blessing to a wave of companies, including asset managers like T. Rowe Price and Fidelity, to use their own versions of the products in their own funds, and to a company called Blue Tractor, which will license its version, Shielded Alpha, to asset managers. That follows an initial approval , in May, for a company called Precidian to offer its “ActiveShares” product to asset manager licensees.

(For some context on how long the non-transparent evolution has been in the making, T. Rowe said in an emailed statement that it first applied for SEC approval in 2013; Precidian has been working on the idea for over 11 years.)

Related: These are the companies that open — and close — the most ETFs

Todd Rosenbluth, head of fund research at CFRA, calls the wave of approvals the start of “a new chapter” in the history of ETFs. Rosenbluth believes ETF benefits compared to mutual funds are so compelling to both asset managers and end investors that the new products will likely prove popular, though he hedges his bets: “Time will tell,” he told MarketWatch.

But Cathie Wood, who actively manages several fully transparent, innovation-themed funds as CEO of Ark Invest, told MarketWatch last month that “there’s a lot of skepticism” in the industry around the new products.

“One of the hallmarks of ETFs is transparency,” Wood said. “We shall see. We welcome more active players in the ETF space. We think it’s a fantastic wrapper, it’s great for the end client. Maybe non-transparent is a bridge (active managers) have to cross to get comfortable with ETFs.”

Read: Welcome to the adult table: SEC sets new ETF rules

In an emailed statement, T. Rowe head of exchange-traded funds Tim Coyne said, “Passively managed, index-based strategies have fueled the growth of ETFs thus far. But we believe that semi-transparent, actively managed ETFs from a trusted brand like T. Rowe Price have the potential to gain traction with investors and advisors who are already interested in active management but who might prefer the ETF structure. We believe this is a significant milestone that will lead to opening a new avenue for our business.”

In an interview with MarketWatch, Blue Tractor co-founders Simon Goulet and Terry Norman wouldn’t comment on whether the company had formally licensed its product to asset managers yet, but said the company has had “lots of interest.”

Among other things, Blue Tractor claims to be more transparent, within the context of the non-transparent universe, than its competitors.

What makes the non-transparent arrangement work is the presence of a third party, sometimes called a market maker or an “authorized participant,” which knows enough about the fund’s portfolio to keep the securities it owns roughly in line with how its shares trade. Passive and transparent active ETFs already use this same structure; proposed non-transparent funds will just take it a step further. Blue Tractor’s value proposition, for example, is that funds using its structure will disclose fund holdings — but not their weightings — every day.

Most ETF-watchers, from Goulet and Norman to CFRA’s Rosenbluth, agree that much of the discussion is back-office jockeying that most individual investors will never know about. “If an investor like Warren Buffett is using Precidian or Blue Tractor, Joe Retail has no idea,” Norman said.

And while some industry watchers think buy-in for non-transparent products may be smoothed by financial advisers encouraging clients to invest, it’s not clear that many of them are entirely convinced. James Werner helps manage about $240 million for high-net worth households at Austin-based Silicon Hills Wealth Management. Werner told MarketWatch last month that he loves ETFs and embraces actively-managed ones for his clients, but non-transparent leaves him cold.

“I don’t know that opaqueness has ever benefited anyone,” Werner said. “Part of the argument (for nontransparent) is we have some intellectual property that we don’t want to put out there in a fund, so people could steal it. I just think that’s a little bit of hubris.”

Related: More evidence that passive fund management beats active

Andrea Riquier reports on housing and banking from MarketWatch's New York newsroom. Follow her on Twitter @ARiquier.

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