Can Nontransparent ETFs Save Active Mgmt?

June 13, 2019

Game Changer?

ActiveShares potentially changes the game for active ETFs. The following fund companies have already licensed ActiveShares from Precidian: Legg Mason, BlackRock, Capital Group, J.P. Morgan, Nationwide, Gabelli, Columbia and Nuveen. American Century has taken the additional step of filing for exemptive relief to launch ActiveShares ETFs. These same nine companies have watched investors pull billions of dollars from their actively managed stock mutual funds.

 

Source: Financial Times

 

The rationale for embracing ActiveShares is logical: If ETFs offer a superior investment delivery vehicle, and fund companies can also protect their “secret sauce,” this seems like a no-brainer. And, with lower costs and without the tax drag, perhaps active managers can close the performance gap or even—gasp(!)—generate more consistent outperformance.

“What we’re doing now is leveling the playing field for the active manager who can provide alpha, and allow him to bring his wares to the market,” Precidian’s McCabe said.

Model Still Faces Obstacles

Could nontransparent ETFs be the savior active management is so desperately seeking? Perhaps, but there are four potential roadblocks to salvation:

  1. Fund companies will have a difficult decision to make. Launching (likely) lower-cost ActiveShares ETFs competes directly with their mutual fund cash cows.3 Given the benefits of the ETF wrapper—especially tax efficiency—this puts fund companies in a slippery situation. As McCabe noted, nontransparent ETFs are now leveling the playing field. The ETF is a superior overall investment vehicle. This says everything about the challenge fund companies face adopting nontransparent ETFs. How will they market nontransparent ETFs? Will they basically say mutual funds are inferior? This challenge is why Matt Hougan, head of research at Bitwise and longtime ETF industry veteran, told Barron’s the rollout of ActiveShares is “one of the last steps in the dinosaur-ification of the mutual fund.” Are fund companies willing to help facilitate the extinction of their own mutual fund cash cows?

 

  1. Performance. The underperformance of active stock fund managers has been well-documented. I’m not going to regurgitate the stats (read about them here and here). Will ActiveShares help? It should. Fund fees and taxes eat into returns. Lowering both through a better structure should provide a boost. ActiveShares’ fees will still be higher than plain vanilla index funds. Can active managers consistently clear that fee hurdle, even if lowered? There is no question that since the financial crisis, the stock market hasn’t been ideal for active management. The S&P 500 has defeated nearly all comers. Could a different, more challenging market environment help shift the tide? Perhaps, though the data doesn’t support that idea. For any type of fund, performance dictates success. ActiveShares will need to have it.

 

  1. Smart beta ETFs. Is active management being automated altogether anyway? Do investors even want human managers—who are subject to the same emotions and biases as all of us—picking stocks? Smart beta ETFs offer the automation of active management, using a rules-based approach in an attempt to provide higher risk-adjusted returns. Is this the future? We don’t know yet, but at a minimum, it’s an obstacle for traditional active managers.

 

 

 

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