John Hyland, CFA, is a retired ETF executive and longtime investment industry professional who has contributed articles to ETF.com. He currently sits as an independent director on the board of the Esoterica NextG Economy ETF (ticker: WUGI). Hyland is also a director of Matthews International, the investment advisor to the Matthews Asia family of mutual funds.
We recently passed the one-year mark on the launch of the first of many actively managed, but not fully transparent ETFs—although the jury is still out on exactly what to call them. For example, they are more semitransparent than nontransparent. At the end of day, these are active ETFs.
So with the full slate of active options now in the exchange-traded wrapper, let’s take a look at the first-grade report card.
FUND NUMBERS
There are now six different SEC-approved structures currently on the market. They include structures from the very first issuer to launch such an ETF, Precidian, as well as Blue Tractor, Fidelity, Invesco, the NYSE and T. Rowe Price. Getting six varying fund wrapper styles through the SEC, and actually launching products using them, was an impressive feat.
After one year, there are more than 30 of these new-style ETFs from 10 different issuers. Given that the first ones launched at the end of March 2020, and that a little thing called COVID hit right about the same time, these are very good numbers.
To put that in comparison, it took commodity ETFs two years to get to just 10 ETFs, and it took fixed income ETFs five years to get to 10 ETFs.
Regarding actual asset flows, the combined assets under management (AUM) of these new style funds is about $1.5 billion. At first glance, that seems a bit modest, particularly when ETFs as a whole brought in $500 billion in flows over roughly the same time period.
Not So Fast…
However, industry insiders may disagree with that assessment, so I have heard. One industry insider pointed out that if you look at the results so far for these new funds and compare their AUM after a year to how other new-style ETFs did when they first started—for instance fixed income ETFs in their first year—the results are very good.
It might be fair to say that the new ETFs get good grades for approved structure numbers and number of funds, but perhaps a bit less for solid, but not eye-popping, AUM growth.
GRADE: A-
TRADING
Several months before the launch of the first of these ETFs, we ran an article that sought to quantify what sort of bid/ask spreads we might see when these funds finally did launch. We did this by looking at the trading of active, semitransparent ETFs on the Australian Stock Exchange. (Read: Aussie Lessons About Nontransparent ETFs)
Those ETFs own just domestic equities—that is, just Australian stocks—and they tended to trade around 9 cents wide, assuming a $25 net asset value (NAV). The aforementioned article forecast that due to more liquid U.S. equity markets, we should expect U.S. active, semitransparent ETFs to trade a few pennies better than that.
We clearly underestimated the skill of U.S. market makers. Right now, these new ETFs are tending to trade on average closer to 3-4 cents wide, once again assuming a $25 NAV, which is better than the article expected. However, when asked, both issuers and market makers all say that this is pretty much what they expected.
Also interesting is that the different structures all seem to be seeing pretty similar tight spreads, despite not all having identical wrappers. ETF market makers state that although there are small differences in how the wrappers work, from their standpoint, they find that all of them work equally well. Differences in actual spreads, they say, usually have more to do with differences in underlying holdings and not the wrapper.
FUTURE FUNDS PIPELINE
Although there are six different firms with approved structures, and most are offering to license their structure to mutual fund and ETF issuers, Precidian, Blue Tractor and Fidelity seem to be seeing the most interest from potential issuers.
All report large numbers of firms have contacted them and, in some cases, have signed up to use the wrapper. Although it is highly likely that the same mutual fund company will talk to multiple structure providers—and thus you have to be careful about double-counting interest—the responses from the firms suggest that the number of potential issuers kicking the tires must be well north of 50 firms, while the number of firms that have actually signed up for a license is more than 20 ETF issuers.
Mutual Fund To ETF Conversions
The obvious candidates to use the new wrapper are, of course, mutual fund issuers; in particular, those who have not developed ETF offerings, as well as established ETF issuers. There is also a less obvious third candidate. That would be smaller asset managers, managing, say, $10 billion to $20 billion, that currently offer separately managed accounts (SMAs).
They will likely have a major issue with getting distribution for their portfolios. They could offer their SMA portfolios as mutual funds, but that still leaves them with major distribution problems. However, if they offer them as ETFs, it solves a lot of the investor access issues by listing on Cboe, NYSE or Nasdaq.
GRADE: A
BROKERAGE PLATFORM ADOPTION
Although in theory investors should have an easy time accessing these ETFs through their brokerage account, in reality, brokerage platforms like Charles Schwab or Merrill Lynch usually have to sign off on making any ETF readily available.
For most platforms, there is a process to go through. In addition, brokerage platforms normally receive some payment from mutual fund issuers for allowing their funds onto the broker’s offering list. They don’t want to see all that revenue disappear, so they are looking to collect some number of basis points, perhaps 10 basis points, from the ETF issuer.
As a result, the process of having these new ETFs being easily available to any investor is an ongoing process. However, industry insiders expect it to largely be a done deal by the end of this year.
GRADE: C+
EXPANDED PORTFOLIO HOLDINGS
At present, the active ETF structures are limited to equity holdings that trade in the U.S. (or on exchanges, like in Canada, that share the same market hours). So, no fixed income and no Europe or Asia equity holdings unless they trade in the U.S. as an ADR.
This is because the SEC wanted to see that the new wrappers traded well when both the ETF and the holdings of the ETF shared the same market hours before they would allow the structure to have the ETF trade on U.S. market hours while the holdings traded in London or Tokyo on different market hours.
A casual observer might look at how well the current versions work, as well as how well U.S. market makers do in trading passive or active ETFs that already hold Europe, Asia and emerging market equities trading on non-U.S. hours, and then think it should be fairly easy to expand the permitted holdings.
Small Nuances Cannot Be Overlooked
But industry experts are not so quick to agree.
“The SEC expanding this to include equities trading on major non-U.S. venue-like London or Tokyo is fairly straightforward,” stated longtime ETF market maker executive Reggie Browne of GTS. “But when you get to some of these emerging market exchanges with very different trading procedures, holiday schedules and settlement processes, the SEC has to think through a lot of small nuances.”
Reggie says he can easily see the SEC doing the expansion in permitted holds in two separate steps, with emerging markets coming after developed markets.
GRADE: Incomplete
Final Active ETF Grade
Overall, the rollout of these new structures seems to be going pretty well, despite some naysayers.
There have been no real problems and a number of areas that have gone very well.
The rollout occurred both amid the disruption created by COVID and while the SEC was dealing with the change in administrations. Things could easily have gone very differently. And may very soon.
OVERALL GRADE: B+
John Hyland can be reached at johnthyland@hotmail.com
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