The big knock on the ETF industry as of late has been the proliferation of products and the notion that all new ETFs are gimmicky in nature and not based on true investment insight. This has led many to argue that there has been precious little true evolution in product, and as a result, very few product innovations that have resulted in substantively better outcomes for end-investors.
This may have finally changed with the advent of the long-awaited semitransparent active ETF known as the Precidian ActiveShares Model. This new structure could change the industry by allowing for active managers with tried-and-true equity strategies to finally feel comfortable taking advantage of the ETF wrapper.
Active mutual fund managers have traditionally shunned the ETF structure due to concerns about having to disclose their holdings on an ongoing basis, despite the clear advantages for ETFs in trading flexibility, tax efficiency and lower costs. This new semitransparent structure allows those managers to worry less about their trades being front-run and exposing their "secret sauce" to the competition and the market at large. It works by allowing windows of transparency when holdings and trades are available to the trading public every 15 or 30 days.
With the phantom of front running and intellectual property theft considerably reduced, active managers are able to take advantage of the ETFs’ better tax structure and improve the experience for end-investors. Over the long term, a more tax-efficient tax vehicle like the ETF structure presents as a better mousetrap, and though tax considerations may slow the migration, it will happen. In fact, discussion regarding open-end mutual funds converting to semitransparent active ETFs is rampant, and Ropes and Gray has already put out an informative paper on the hypothetical process.
I believe the widespread adoption of the new structure is inevitable in the equity market, in part because we have already seen it happen in the fixed income arena. Active ETFs have seen significant adoption in the bond world, partly because the fixed income market is opaque to begin with, so transparency was never an issue. In fact, currently 16 of the 20 largest active ETFs are fixed income oriented. Now that there has been a solution to the transparency issue on the equity side, I expect the Precidian model to be swiftly and eagerly adopted by active equity managers, especially as fee wars on the active side continue to mimic those on the passive side.
There are some who have voiced concerns about whether investors will benefit from this new model, or whether it ultimately just portends a last gasp for active managers. Like many, I believe the industry has room for both passive and active strategies, but the celebratory thing about the ETF ecosystem is that it is self-cleansing. Only the products with real investment merit will survive. Whichever active ETFs thrive and attract assets will be among the best active strategies available, and those that lack merit will be forced to close.
It must be noted that active mutual funds still make up a much larger percentage of assets than the overall ETF market does (approximately 12 trillion in mutual funds versus 4 trillion in ETFs). But ETFs are catching up, and actively managed ETFs in the U.S. grew their assets under management by 66.4% versus 11.5% for passively managed ones in 2018, according to ETFGI. While it has been a long wait, it seems active equity managers finally have the tools to embrace the ETF structure, and their doing so may give a boost to the whole industry.
John Swolfs is the CEO of Inside ETFs.
