20 April 2024

A New Era Dawns for ETFs: ‘Nontransparent’

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Twenty-one years after the first exchange-traded fund arrived as an alternative to the traditional mutual fund, a new regulatory ruling could spur a rush into the ETF vehicle by traditional stock-picking asset managers. The Securities and Exchange Commission late Thursday cleared Boston-based Eaton Vance to launch a so-called nontransparent ETF that will trade on an exchange but that doesn’t have to disclose its holdings and doesn’t follow an index. Eaton Vance has plans to launch 18 such funds over the coming months, the first fund company to do so.

Last month the SEC rejected a proposal for a competing nontransparent-ETF design from BlackRock and Precidian Investments. The SEC ruling may initially be more exciting for asset-management companies than for individual investors.

In recent years, many investors have shifted dollars from actively managed stock funds to index mutual funds and ETFs, most of which follow an index. Few established fund companies have been willing to offer actively managed stock ETFs, mostly out of concern that the required daily disclosure of their holdings would allow other market participants to front-run their buying and selling. Managers have generally been less concerned about front-running with bond portfolios; some large companies, including Pacific Investment Management Co., offer transparent active bond ETFs.

The new nontransparent design—which Eaton Vance said it would offer to license to other companies—could make more fund companies comfortable with offering active stock ETFs. That could potentially include ETF versions of big, well-known stock mutual funds.

For investors, however, active stock ETFs raise many of the same issues as active stock mutual funds, as my colleague Ari Weinberg wrote in an article on active stock ETFs in March:

The fundamental challenge facing actively managed equity ETFs is the same one facing conventional stock mutual funds: The odds are stacked against active management.

While some active managers invariably will beat their benchmarks, others will trail theirs. On average, fund investors can expect to get market returns, reduced by the funds’ expenses, which generally are higher for active managers than for index funds because investors are paying for a stock picker’s expertise.

Active stock ETFs could potentially be less costly for investors than active stock mutual funds, as there are typically fewer administrative and distribution-related costs baked into ETF expense ratios. ETFs also don’t have sales commissions, as some mutual funds do. But if offering an active stock ETF required paying a licensing fee for the nontransparent product design, that would be an added expense compared with an index ETF.

Click here to access the full article on The Wall Street Journal. 

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