For investors currently owning traditional active stock mutual funds, converting to nontransparent ETFs might make sense. Investors won’t lose anything, and they will likely gain lower costs, tax efficiency and intraday trading. Perhaps that will be enough to ignite nontransparent ETFs.
But what if fund managers offering transparent active ETFs are able to deliver a similar performance track record? If investors can get the exact same experience—with more transparency—why wouldn’t they do that?
Whichever direction fund companies choose—transparent or nontransparent ETFs—they are going to cannibalize their existing mutual fund business. That’s a fact. My preference is to see investment strategies delivered in the most investor-friendly format. But as I mentioned earlier, ultimately, performance will hold the key.
If there is some credence to the “secret sauce” and “front-running” arguments, that should show up in the numbers. If performance doesn’t materialize, nontransparent ETFs will have a short life span. And, regardless of whether transparent or nontransparent, active has to continue battling the major head wind posed by passive investing.
“I appreciate the point that, early on, ETF growth was all about passive management, but we see active ETFs as the next stage in the evolution of the business,” said Rick Genoni, head of ETF product management at Legg Mason.
I agree, but transparent or nontransparent active ETFs? Investors will ultimately decide.
1Everyone except Vanguard, whose ETFs are a share class of existing mutual funds, and disclose holdings monthly.
2Note the SEC approval limits ActiveShares ETFs to securities traded on U.S. exchanges during the same time as the ETF.
3In addition to launching stand-alone ActiveShares ETFs, there’s discussion surrounding whether mutual fund companies can simply convert an existing mutual fund into an ETF. Blog for another time.
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