Trending Video: Active Nontransparent ETFs
I'm Brian McCabe, an asset management partner in Ropes & Gray's Boston office. In this video, I'm going to discuss active nontransparent ETFs and the opportunities they offer to investors and asset managers of traditional mutual funds.
Potential benefits of ETFs relative to mutual funds
ETFs generally have a significant tax advantage over mutual funds. There's no reason why they have to because traditional mutual funds could transact in kind, but as a practical matter, they really don't – that's one tenth of one percent or less of their transactions are going to be in kind. In kind transactions are much more tax efficient, so the primary benefit, I'd say, is a tax benefit. You also pick up savings in transfer agency costs because ETFs generally don't pay transfer agency costs, and traditional mutual funds do. In addition, ETFs generally don't pay 12b-1 fees, distribution costs that are usually embedded in a mutual fund. So taken together over time, you're going to generally save money in an ETF relative to a mutual fund – people talk about that being the wrapper (the ETF or the mutual fund). If it's offered, you can get the same strategy in either wrapper and so the cost differences can really drive the choice of the wrapper that you're looking for.
Opportunities for traditional active asset managers
For traditional managers who weren't offering ETFs, a lot of them have been looking at the ETF market, seeing it growing, and saying, "Gee, wouldn't it have been nice had I known this was going to happen. It might've been nice to be in the ETF space." This represents another natural entry point. Until the SEC approved the active nontransparent orders last year, an active manager basically couldn't offer the same strategy in the ETF without giving away its secret sauce by posting its portfolio every day on trade day plus one. So if it takes you more than one day to build your positions, the fear is that the market might be able to see a manager coming, front run the manager, or just be a free rider and say, "Well, I'll just buy tomorrow, whatever that is in that fund today and not have to pay the management fee." The new nontransparent models offer a way to protect the alpha, the intellectual property of the asset manager while still getting into the ETF market. So it's an opportunity for asset managers to move into a new vehicle and offer their existing strategies or new strategies in ways that don't give away the store.
Challenges of offering “clones” of successful traditional funds
There are a lot of advantages to using clones if you're an active manager because your product is well-known, proven, accepted in the marketplace, brand recognition, scale – there are a lot of good reasons to have your initial ETF offering be a clone of your successful traditional funds. The big challenge is trying to figure out pricing because even if you set your management fee equally across the two vehicles, because of the cost advantages of ETFs, transfer agency costs, 12b-1 fees that ETFs don't bear, the ETF is generally going to be less expensive than the traditional mutual fund. So traditional managers are concerned that they might be cannibalizing their existing products, that people might move from the traditional fund into the ETF. Similarly, intermediaries who have sold the traditional fund might be worried that their clients might move over to some cheaper product on which they can't get a 12b-1. So it's more of a business challenge than a legal challenge, but those are the issues that a lot of traditional asset managers are wrestling with in this space.