SEC Gives Nod to More Nontransparent, Actively Managed ETFs

They are viewed as the third phase in the development of exchange-traded funds.

The Securities and Exchange Commission (SEC) has just approved more nontransparent, actively managed exchange-traded funds (ETFs).

“The current percentage of ETF assets in active strategies has been growing—but is still only 2%,” says David Mann, head of global ETF capital markets at Franklin Templeton. “We are believers in the value of active management, so we are eager to see different styles and types of ETFs available in the marketplace and welcome this latest news. We will be watching if these new forms of ETFs help those percentages increase.”

Mann says he was not surprised by the SEC’s latest move, as earlier this year, the SEC gave permission to Precidian to offer a nontransparent, actively managed ETF. “Once that happened, it seemed they would get comfortable with other variations.”

In order for this new type of ETF to be successful, Mann says, “the spread between the bid and the ask will need to be tight. If not, investors are not likely to want to trade them.”

Another headwind that these new iterations of ETFs could face is “they won’t have big trading volumes or a track record,” Mann says. “So, getting that adoption will be interesting.”

For example, Mann says, three years ago, Franklin Templeton launched an actively managed, low volatility ETF tracking U.S. equities. “Its performance has been lights out—but getting increased interest in it has been a challenge because offering actively managed ETFs has been a battle so far. So, here is a super-high performing fund in an asset class that people want, and it is still a challenge, so it wouldn’t surprise me if these new funds face similar headwinds.”

Grant Engelbart, senior portfolio manager and director of research for CLS Investments, is more optimistic about the new offerings. In fact, he thinks “there could be substantial runway for these strategies.”

Engelbart calls the new developments the third phase of ETF developments. “The first was the introduction of ETFs tracking market cap-weighted indices,” he says. “The second was the introduction of smart beta ETFs tracking non market-cap weighted indices by valuations or niche areas of the market. Third could be the third phase and represent a huge step toward tax efficiency in the mutual fund space.”