The fast-growing U.S. ETF market could be transformed by major changes in the next few years. Here are six key areas to watch.
1. The Debut of Non-Transparent Actively Managed ETFs
Before year-end, the first non-transparent actively managed ETFs are expected to come to market, according to Daniel McCabe, CEO of Precidian Investments, which developed the strategy that allows ETFs to conceal holdings from investors for months at a time. The Securities and Exchange Commission approved the strategy in April.
A recent Cerulli Associates survey of 35 asset managers found that that 46% indicated they would build nontransparent ETF capabilities.
Douglas Yones, head of exchange-traded products at the NYSE, says the introduction of nontransparent active ETFs could prove to be a “watershed moment” for the ETF industry, leading to an explosion of AUM above the almost $4 trillion that traditional transparent ETFs hold today.
2. Threats to the Tax Efficiency of ETFs
The ETF tax efficiency advantage could end because the more popular ETFs become, the more revenue the U.S. Treasury forfeits as a result.
Unlike mutual funds, ETFs are not required to distribute capital gains to shareholders when their securities are sold for a profit to meet redemptions or free up cash for new investments. When redeeming — and creating — shares, ETFs use in-kind transactions, which are not considered cash transactions and therefore do not result in pass-through capital gains.
Fordham University of Law Professor Jeffrey Colon has called for the repeal of Section 852 (b) (6) of the Internal Revenue Code, which allows for the tax-free distribution of capital gains in ETFs and in mutual funds. He labels the taxation of in-kind ETF redemptions “the great ETF tax swindle.”