The other big idea that’s been coursing through the SEC for the better part of three years is a nontransparent ETF that would keep its portfolio holdings concealed through the use of a blind trust at the center of the creation/redemption mechanism.
APs for the products would be doing creations and redemptions for cash and hedging the funds based on the fact that they could redeem shares for the exact cash value of the funds’ net asset value. Within the blind trust, creations and redemptions would happen in-kind, allowing the fund to enjoy some of the tax efficiencies that transparent ETFs currently enjoy.
Crucially, the blind trust would be able to do what APs at the center of any index-based ETF are able to do as well, such as eliminating higher-cost securities to get rid of embedded capital gains at the fund level. Such cherry-picking of securities is a key reason ETFs are considered to be more tax efficient than mutual funds.
Precidian Investments, the money management firm with the patent to run active ETFs this way, has two major parties that have licensed the idea: none other than the world’s two biggest ETF companies—BlackRock’s iShares and State Street Global Advisors. Both ETF firms, armed with the patent from Precidian, have petitioned the SEC to earn the legal right to market these proposed active ETFs.
Adding to the sense that this idea may have legs is that Precidian itself, which has also petitioned the SEC to market funds using its own idea, has filed a separate registration statement detailing three nontransparent, active U.S.-focused equity funds.
The Precidian registration statement is a case of putting the cart ahead of the horse. But industry chatter suggests that both the Eaton Vance and the Precidian plans are close to being approved by the SEC, implying that registering actual funds before the approval of the idea isn’t just wishful thinking.
If that is indeed the case, then investors will, at the very least, be subject to sales and marketing efforts worthy of the biggest and most influential fund companies in the world, including Wall Street stalwarts like J.P. Morgan.
What’s Active, Anyway?
But then again, there is a question of what, exactly, constitutes active asset management. A lot has changed, as noted, since the Magellan Fund’s halcyon era, from the increasing popularity of quasi-active “smart beta” strategies that are designed to beat broad cap-weighted indexes, to the fact that index ETFs are increasingly being used as building blocks for active asset allocation.
Upward of $200 billion in ETF assets are now in smart-beta funds. That’s around 12% of all ETF assets, and investor interest in fundamental indexing and broad funds like the PowerShares FTSE RAFI US 1000 Portfolio (PRF | A-88) and in other rules-based factor tilts is only growing.
“I don’t particularly like the name ‘smart beta,’ but I do think there are investors who feel disenfranchised and don’t necessarily believe that most managers can outperform,” said Fuhr.
Additionally, one of the fastest-growing pockets in the world of exchange-traded funds is the realm of “ETF strategists,” who, by and large, use index ETFs to deliver outperformance to their clients. Even Vanguard, an index shop at its core, began talking to investors in the past year about ways to use its plain-vanilla, cap-weighted index ETFs to formulate top-down alpha-seeking tilts.
“We don’t have any interest in active ETFs, because when we buy an ETF, we want pure exposure,” said Brian Schreiner, president of Pa.-based Schreiner Capital Management, echoing a sentiment of many ETF-focused money managers. But Schreiner says that, on rare occasions, his firm has made use of “smart-beta” tilts.
Perhaps most damning to the outlook for active ETFs is that many investors have grown skeptical that active managers can indeed outperform their benchmarks over time.