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A Flood of Nontransparent Active ETFs Could Be Coming — Soon

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Once the Securities and Exchange Commission approves the first strategy for nontransparent actively managed ETFs, which could happen as early as this Friday, many more such ETFs could be coming to market.

(Related: SEC OKs a Nontransparent Active ETF Strategy, but Will Investors Care?)

A Cerulli Associates survey of “product heads” from 35 asset managers found that 46% indicated they would build nontransparent ETF capabilities within a year if the SEC approves the ActiveShares proposal from Precidian Investments. More than half of those asset managers (55%) expect to launch a nontransparent actively managed equity structure; while 30% expect to launch a similar strategy for fixed income investments.

Currently only 2% of ETFs are actively managed and most of those are fixed income products. If the SEC gives final approval to Precidian’s application — it has already given tentative approval — the odds improve for other pending nontransparent actively managed ETF proposals.

Asset managers are either entering into licensing agreements with firms waiting for approval of their structures, such as Precidian, or filing their own applications for nontransparent actively managed strategies.

In the first group are Legg Mason, Capital Group, JPMorgan, Nationwide, Gabelli, Columbia, American Century and Nuveen which have already licensed ActiveShares from Precidian. In the latter group are NYSE/Natixis, Fidelity, T. Rowe Price, Blue Tractor Group and Eaton Vance, which already offers NextShares, an actively managed exchange managed fund, which has characteristics of both mutual funds and ETFs but has failed to attract much investor interest.

Each of these (new) filings for an actively managed nontransparent ETF “sits on a spectrum of transparency,” according to Cerulli. Fidelity’s proposal includes an optimized tracking basket that has similar exposures to securities in the ETF but are not all the same securities and weights of the actual fund holdings. Blue Tractor’s Shielded Alpha proposal reveals all the fund holdings but scrambles the weights.

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Even if the SEC approves all these applications, questions remain about the demand for such products, which lack the transparency that ETFs traditionally have and that has been a key selling point for these funds.

Most ETFs are passive index investments that reveal their holdings daily. In the case of the Precidian Investments filing, holdings would be disclosed on a quarterly basis with a lag, as most mutual funds do.

The Cerilli report notes that “expectations for actively managed ETFs are tempered” and the “tenets that have made ETFs successful — low cost, transparency and passive management — will not apply here.”

Of the roughly 20 ETF strategists Cerulli polled, 53% said they would not use nontransparent active equity ETFs due in part to the need to model the underlying holdings, which they would not be privy to on a daily basis. Cerulli defines ETF strategists as that “subset” of model providers that use ETFs as their building block investment products (strategies), which include such firms as Richard Bernstein Advisors, Riverfront and Stadion Money Management.

“Nontransparent structures may be able to deliver strategies that investors seek in a more accessible vehicle; however, the lack of transparency is a key trade-off,” according to the Cerulli report. It adds that unless these “more complex vehicles [are] significantly less expensive than their traditional fund counterparts” investors may consider them “poor alternatives to existing open-end, closed-end and ETF products.”

— Related on ThinkAdvisor: Nontransparent ETFs Could Be Game Changer for Fund Market