How Advisors Are Using Active Semitransparent ETFs in Client Portfolios

Active semitransparent exchange-traded funds launched in 2020, one year after the U.S. Securities and Exchange Commission approved the listing of these niche ETFs.

Although active ETFs represent only 3.5% of the U.S.-listed ETF universe, they are “increasingly being viewed as sound investments,” says Todd Rosenbluth, head of ETF and mutual fund research at CFRA, a New York financial research company.

Semitransparent ETFs, which are also called nontransparent ETFs, are actively managed and provide limited and delayed disclosure of the full portfolio, but offer sufficient information to allow the ETFs to trade properly, he says. Since there is enough disclosure about the stocks held in them, investors can make informed decisions.

“Unlike mutual funds, these ETFs can be purchased or sold intraday, do not need to hold cash to meet redemptions and are likely more tax efficient,” Rosenbluth says.

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The Difference in Transparency

The first semitransparent ETF using both the New York Stock Exchange Active Proxy Structure and T. Rowe Price’s proxy model went public during the third quarter of 2020. The first 15 semitransparent ETFs raised more than $600 million in assets under management in 2020, demonstrating investor demand, wrote Douglas Yones, head of exchange-traded products at the New York Stock Exchange, in a blog post.

ETFs are required to report their holdings to the SEC on a daily basis, which allows investors to see which stocks and bonds they bought and sold.

You can see what you’re buying, just like looking at the ingredients of your smoothie as it’s being made, says Brian Blackwell, director of financial planning at Spotlight Asset Group, a Marietta, Georgia-based registered investment advisor.

Under the exemption provided to certain firms by the SEC, semitransparent ETFs only have to report their holdings on a quarterly basis, he says.

While this reduces transparency to the investor, it does give the fund managers an advantage since they can make investment decisions without tipping their hands.

“By keeping the holdings secret, these kinds of ETFs reduce the risk that other managers will predict and copy their investment strategy,” Blackwell says.

The advantage of actively managed ETFs is that the portfolio managers are attempting to beat their indexed or passive counterparts over time. They charge a higher management fee, however, for the extra work that goes into researching companies in which to invest.

Investors will need to evaluate these costs, possible alternatives and the potential tax impact of these ETFs before investing in them, he says.

There is a good number of semitransparent ETFs that are essentially the ETF version of an already existing mutual fund, Blackwell says.

He points out the Fidelity Blue Chip Growth Fund (ticker: FBCGX) has a semitransparent ETF counterpart, FBCG, that was created on June 2, 2020. “Notice also the difference in expense ratio — 0.45% for the former and 0.59% for the latter,” he says.

Investors and financial advisors should understand that all semitransparent ETFs are actively managed, but not all actively managed ETFs are semitransparent.

“It depends on their disclosure requirements,” he says. “If the fund is trading actively, but is required to disclose their positions daily, it is not considered semitransparent. Remember, only certain firms were given permission to offer these ETFs.”

[READ: Q&A: An ETF for Investors With FOMO.]

How Advisors Use Active Semitransparent ETFs

Semitransparent ETFs should be used just like any other ETF in an investor’s portfolio by an advisor, says Josh Simpson, a financial advisor with Lake Advisory Group in Lady Lake, Florida.

“The only real discernible difference at this point, because these are new products that just started trading in 2020, is the frequency with which the fund managers have to disclose their holdings,” he says.

Semitransparent ETFs and actively managed ETFs also have lower costs than many mutual funds, Simpson says.

Since the holdings in these ETFs are not disclosed daily, it may be more difficult to determine a proper price for these investments on a daily basis.

Other concerns are the tax efficiency of the funds as well as internal costs that exist. Those depend on the age and financial situation of a client, he says.

“Since these are relatively new investment products and only started trading in 2020, there is very little data to work with,” Simpson says. “But so far, the results have shown that the internal costs, tax efficiency and trading price have been very similar to traditional ETFs.”

Semitransparent ETFs are essentially not any different from any other ETF from an investor or advisor’s point of view, says Michael Esselman, interim chief investment officer at OneDigital, an Atlanta-based health, retirement and human resources advisory firm.

“Investors should focus on the same things for any other ETF they are looking at: Does it complement my other holdings? How does it increase the return profile or decrease my portfolio’s risk profile? Do I understand the strategy and trust the management team and so on?” he says.

These ETFs are the answer for active managers, and they can now launch an ETF and protect themselves from “competitor attacks,” Esselman says.

[Read: Q&A: Using a Natural Resources ETF to Combat Inflation]

Another factor to pay attention to is the deviations between the market price and the net asset value, he says.

“The mechanisms behind semitransparent ETFs are still being worked through, so it is even more critical to monitor this closely,” Esselman says. “Additionally, understand the bid-ask spread and look to see if the gap remains small or gets wide at times.”

Over the past 20 years, active funds have only outperformed their benchmarks in six quarters by less than 2%, says Bob Tull, president of Procure Holdings in Levittown, Pennsylvania, who has helped launch over 400 ETFs in 18 different countries since 1996.

The choice to be semitransparent is typically driven by the investment management team, he says.

“The investment manager would believe that their investment’s ‘secret sauce’ is protected from front-running by trading desks that could negatively impact the returns to investors,” Tull says.

Many of the semitransparent ETFs use other ETFs in their portfolio creation and redemption process, similar to a fund of funds.

“In this way, the investor can have a significant amount of market exposure and diversification through a small number of securities,” he says. “One would expect semitransparent ETFs to have narrow spreads in the exchange bid-offer as securities have actionable bid-offer spreads.”

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