Five years after the SEC approved non-transparent, actively managed ETFs, the vehicles have struggled to gain traction. Their opacity and lack of differentiation from transparent, actively managed ETFs have left investors unenthusiastic, industry insiders say.
Unlike regular ETFs, non-transparent, actively managed ETFs don’t have to report their holdings daily. Instead, these funds file reports monthly or quarterly, functioning more like mutual funds. Out of 70 such ETFs launched since 2016, only 50 remained in the market by February 2024, according to a report published last week by investment research provider Morningstar. Together, they hold $5.2 billion in assets, less than 1% of the $530 billion in assets under management for all actively managed ETFs in the United States. That’s even though several popular asset managers, including Fidelity, Nuveen and T. Rowe Price, jumped on the bandwagon and launched products.
Limited transparency can be a boon for asset managers, allowing them to protect the secrets of their investment strategy, noted Bryan Armour, director of passive strategies research, North America, with Morningstar. However, “I don’t think it’s something that helps investors at all. The problem is that they require complex processes to work.”
In addition to reporting their holdings less frequently than regular ETFs, non-transparent ETFs don’t have a standardized method for reporting what they have in their portfolios, Armour noted. The SEC approved several different methodologies for how these vehicles could report, ranging from an NAV figure plus or minus a penny to using proxy stocks that are similar in price but not the same as the non-transparent ETF’s actual holdings. These complicated frameworks tend to confuse investors, and many opted to stay away, according to Armour.
Meanwhile, because SEC regulations limit non-transparent active ETFs to investing in U.S. exchange-traded securities, they can’t take advantage of the active management strategies that are most likely to deliver outsized returns, said Lara Crigger, editor-in-chief at financial consulting firm VettaFi. She noted that active management tends to add the most value in markets or asset classes where price discovery or access is difficult for the average investor. The SEC’s guidelines for non-transparent ETFs “kind of take a lot of the tools out of the toolbox for active managers. What they are left with are U.S. equity securities that maybe aren’t offering enough of a differentiation for investors beyond what they can already find in the marketplace.”
Savvy investors want to understand exactly what they are allocating money to, according to Steve O. Oniya, chief investment officer with Houston-based financial advisory firm OM Investments. “It makes me and others uncomfortable if we cannot at least see the top 10 holdings frequently to check how the fund is performing and managed,” he wrote in an email. “Opacity also limits accountability if you don’t know or understand what you’re supposed to be into.”
Oniya added that his firm would be “cautiously open” to investing in non-transparent, actively managed ETFs if they disclosed their real assets on a limited schedule—for example, quarterly.
The extent to which the lack of transparency can impact inflows can be glimpsed by looking at ETFs managed by T. Rowe Price, according to Crigger. T. Rowe launched its first non-transparent actively managed ETF, Blue Chip Growth ETF (TCHP), in 2020. Since then, the fund has amassed approximately $550 million in net assets. TCHP’s NAV has risen by 2.08% in the past month, so “performance-wise, it’s doing really well,” Crigger said.
In contrast, T. Rowe Price Capital Appreciation Equity ETF (TCAF), which launched last summer and invests in equities benchmarked to the S&P 500, already holds over $1.2 billion in net assets. TCAF reported NAV growth of 2.58% for the past month.
“I think you see very clearly that investors, when given the choice between two different types of T. Rowe Price’s active management strategies, are opting for the transparent version over the non-transparent,” Crigger noted.
The lack of transparency may be keeping non-transparent ETF vehicles out of many model portfolios. RIAs may be reluctant to include them without understanding whether they would lead to over-concentration in specific stocks or sectors or how they would impact risk/return calculations. And inclusion in model portfolios can be crucial to an ETF’s success, Crigger said.
“You have a single percentage inclusion in a model portfolio managed by BlackRock, and suddenly you’ve got billions of dollars moving into that ETF. It does make a big difference.”