Semi-Transparent ETFs Are Alive and Well

Active ETFs have gained in popularity in recent years. However, some pundits have prematurely taken out their shovels for some funds. Even as these products show signs of vitality.  

Last month, the Financial Times published a piece “Secretive active ETFs lose out to their fully transparent rivals” talking about the differences between active ETF structures.  

Active ETFs Are not All Built the Same 

As a refresher, in the last three calendar years asset managers launched many actively managed ETFs. Some active ETFs disclose their holdings daily, much like most index ETFs (more on that in a minute). Others provide delayed disclosure of the full portfolio, much like a mutual fund, and have become known as semi-transparent active ETFs. Both structures aim to deliver outperformance of an index like the S&P 500 rather than replicating it. 

In the Financial Times piece, it was declared by one pundit that “Semi-transparent ETFs are dead… The semi-transparent vehicle had a short life, but we think the end is nigh.” 

VettaFi was quoted in the same article and “argued that for investment houses that offer the same strategy in both ETF and mutual fund formats ‘the semi-transparent approach makes sense’ as ‘all shareholders own the same securities and management can avoid sharing proprietary information.”

At the end of the third quarter of 2023, there was approximately $435 billion in actively managed ETFs across more than 1,100 products. Year-to-date cash flow through September totaled $78 billion with growth accelerating in the third quarter from earlier in the year according to the New York Stock Exchange (NYSE). While more asset managers like Capital Group, Dimensional Funds, Goldman Sachs, and Morgan Stanley are turning to fully transparent products, semi-transparent active funds have a niche. 

What Really Matters With Active ETFs 

In my experience, most advisors and investors look periodically at what’s inside their ETF and some unfortunately never go that deep. They care about an active ETF’s performance, investment approach, and trading behavior. These matter more than the date of holdings disclosure available on a website. I believe this remains true despite the bold letters on fund websites telling us “this fund is different from traditional ETFs.”  

What they mean is holdings are not updated as of the prior business day. However, this has been the case for long-established ETFs like the Vanguard 500 Index ETF (VOO) and Vanguard Total Stock Market Index ETF (VTI). On October 13, the Vanguard websites were still showing holdings as of the end of August, though they have since been updated to September-end data. This has not stopped these Vanguard ETFs from gathering assets. 

The First Wave Semi-Transparent Active ETFs 

The first 14 semi-transparent ETFs launched in 2020, with American Century Focused Dynamic Growth (FDG) as one of the first. FDG is a high-conviction, large-cap growth portfolio that seeks out companies with opportunities to sustain their above-average growth. The American Century fund’s recent 37 holdings included Chipotle Mexican Grill, Constellation Brands, and Regeneron Pharmaceuticals. 

Fidelity and T. Rowe Price soon followed with semi-transparent active ETFs as did many others. Indeed, the number of products more than tripled to 53 as of the end of September 2023. The semi-transparent structure has also served as a gateway to the equity ETF market for others like DoubleLine and First Manhattan. 

As of September 2023, there was $7.1 billion invested in semi-transparent active equity ETFs. This is up more than four-fold from $1.5 billion two years earlier, according to NYSE data. While they make up a small percentage of the total active ETF universe, cash flows for semi-transparent active equity ETFs have grown every quarter since the first funds in 2020. 

Meet More Semi-Transparent Active ETFs  

The DoubleLine Schiller CAPE US Equities ETF (CAPE) launched in 2022. The active ETF aims to identify undervalued sectors based on a modified CAPE ratio. Then it uses a momentum factor to avoid a potential value trap. In August, communications services, consumer staples, financials, and health care. Stocks like Berkshire Hathaway, Meta Platforms, Procter & Gamble, and UnitedHealth Group were recent positions. 

“The methodologies for constructing the Index and the CAPE® ratio are in the public literature,” noted Scott Thomson, ETF specialist at DoubleLine. “However, the active securities selection to compose the ETF portfolio and related trading activity are the work product of DoubleLine’s investment team. A semi-transparent structure was chosen for the ETF to protect Barclays and Dr. Shiller’s intellectual property and to protect against frontrunning of the investment team’s securities selection and trading.”  

The First Manhattan Excelsior Focus Equity ETF (FMCX) also launched in 2022. FMCX is another high-conviction, low-turnover ETF that owns just 41 stocks. Management favors companies believed to possess a durable competitive advantage, earn higher-than-average returns on capital, and have opportunities to reinvest excess cash profits at attractive rates of return. Those recently included Berkshire Hathaway, Entegris, and KKR. 

“A research-driven approach to portfolio construction has been at the heart of First Manhattan’s DNA since our founding in 1964, explained Ben Clammer, managing director at First Manhattan.  

“Precidian’s ActiveShares helps us to achieve our goal of bringing an actively managed strategy to the retail investor while helping to protect the proprietary strategies and daily trading activities that underpin the over $20 billion in assets that our firm manages.” Precidian offers one of the handful of ways for asset managers to control their portfolio disclosure and still allow for efficient ETF operations and trading.  

How Well Do Active Semi-Transparent ETFs Trade 

Those looking around for the nearest cemetery are likely comparing CAPE, FDG, and FMCX to active U.S. equity ETFs that disclose holdings daily. While the asset bases are smaller for many semi-transparent ETFs, let’s take a look at how they trade.  

“The trading experience that an investor should have when trading semi-transparent ETFs will be like one when trading any other ETF”, explained Matt Lewis, Vice President and head of ETF Capital Markets at American Century. “These semi-transparent structures were designed to provide ETF market makers real-time metrics and values to be able to quote markets that are in line with the risks associated with the underlying security.    

Active equity ETFs that invest primarily in the U.S., regardless of their disclosure policies, trade with wider spreads than index alternatives per NYSE data. However, in the first nine months of 2023, the median spread for semi-transparent ETFs was 22.5 basis points. This was slightly tighter than the 22.9 basis points for transparent active ETFs. 

Semi-Transparent Active and Fully Transparent Active ETFs Are Alive and Well 

“At the end of the day, these are ETFs and ETF liquidity providers are pros at managing risks associated with trading all ETFs which allows them to provide efficient and fair markets,” added Lewis. 

At VettaFi, we couldn’t agree more. Active ETFs, in general, are alive and well. These funds support advisors’ efforts to meet client needs through discretionary security selection and in a cost-effective manner.

Published: March 29th 2023
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