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The Pros and Cons of Nontransparent ETFs: Morningstar’s Johnson

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Before advisors consider whether to invest in actively managed nontransparent ETFs (ANTs), they might want to consider the pros and cons of this novel investment vehicle. 

There are only a handful of these ETFs on the market now, but they are sure to proliferate since multiple asset managers have filed with the Securities and Exchange Commission for approval to trade such funds, including Goldman Sachs Asset Management and T. Rowe Price. 

ANTs, also known as nontransparent or semi-transparent ETFs, are actively managed ETFs that share one major characteristic with mutual funds: They disclose their holdings with a lag, unlike traditional ETFs, which disclose holdings daily. The delayed disclosure allows portfolio managers to keep their so-called secret sauce secret for a time to prevent copycats. 

Otherwise ANTs are generally like ETFs, with similar advantages over mutual funds: more tax-efficient due to in-kind redemptions; lower fees because they don’t have embedded marketing or distribution costs; trading costs borne by their buyers and sellers, rather than long-term shareholders; and intraday trading and pricing (mutual funds are priced only at the end of daily trading).

As a result of these advantages, there is an expectation that some asset managers will choose to replace their actively managed mutual funds with an ANT that follows the same investment strategy. 

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All the eight ANTs available today — four from American Century, three from Fidelity and one from ClearBridge — have lower fees than the retail share classes of their mutual fund counterparts, according to Ben Johnson, director of global exchange-traded fund research at Morningstar.

He laid out the benefits and drawbacks of ANTs in a recent article on the Morningstar site that can serve as a guide for advisors interested in these new products. Included in his analysis were the following limitations: 

  • ANTs currently can invest only in assets that trade at the same time as the funds themselves. Equity ANTs, in other words are limited to U.S. stocks and to American Depositary Receipts and Global Depositary Receipts of foreign companies. This can hamper a portfolio manager’s ability to invest in their best ideas.
  • ANTs lack the ability to close investments from only new investors, a tactic active mutual fund portfolio managers can use to protect existing shareholders. Given this limitation, ANTs are more likely to favor large-cap stocks, which constitute a highly efficient market that is challenging for stock-pickers. If there is less ability for an actively managed large-cap fund to beat its benchmark than other types of stock funds, is there a need for such a semi-transparent ETF?
  • ANTs may be less tax-efficient than traditional ETFs because they do not have the ability to use custom redemption baskets and they will likely have less turnover. Both can curtail a portfolio manager’s ability to choose the most tax-efficient sales. 
  • ANTS potentially have wider bid-ask spreads than traditional ETFs due to less information disclosed in the market setting their prices along and expected lower volumes.

Johnson concludes that “ANTs have a place” for investors who want to invest with a particular fund manager, but they also involve tradeoffs. In exchange for easy access, lower fees and the potential to be more tax-efficient than retail shares of mutual funds. limitations on portfolio managers can make ANTs less tax-efficient and more costly than traditional ETFs.

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