In 2019, the Securities and Exchange Commission approved a new type of actively managed exchange-traded fund (ETF), interchangeably called semi transparent Where not transparent. The main advantage of these ETF structures (also commonly referred to as an “ETF envelope”) for an active portfolio manager is that they protect the confidential portfolio strategy of a fund and the associated portfolio transactions, thus preventing the front running and free riding.

Six companies have developed various variations of the new ETF structure – Precidian, the New York Stock Exchange, Fidelity, T. Rowe Price, Invesco and Blue Tractor Group – and the intellectual property associated with each of these wrappers is currently licensed under license to fund managers. seeking to bring active strategies exclusive to the world of traditional mutual funds and SMA out of the way into an actively managed ETF.

These ETF envelopes all differ from fully transparent active ETFs in that they are not mandated by the SEC to disclose (through a daily published portfolio composition file, or “PCF”) the exact contents of the sub-portfolio. jacent. Instead, these ETFs are only required to disclose the actual content of their portfolio on a quarterly basis, thus essentially mimicking the transparency of an actively managed mutual fund’s portfolio, while still reaping the benefits of a structure. fully transparent ETFs for investors compared to a mutual fund; including cost reduction, tax efficiency and instant liquidity.

However, the SEC requires these new envelopes to disclose additional information and metrics to the ETF capital markets on a daily basis in order to ensure efficient pricing, trading, liquidity and arbitrage in the primary and secondary markets. In the case of NYSE, Fidelity, T. Rowe Price and Invesco, these ETF wrappers publish a proxy wallet PCF employing substitute securities that mimic (or replace) the actual securities in the portfolio. Precidian’s ETF wrapper does not publish PCFs; instead, the actual portfolio is provided to a special capital markets participant (known as the Participant’s Authorized Representative or “AP-R”) who acts as an intermediary between the ETF and the equity markets. capital. Blue Tractor is totally different as actively managed funds using this wrapper publish a daily PCF which does not use proxy securities and furthermore an AP-R is not a necessary requirement.

The multi-trillion dollar US ETF market is geared towards full portfolio transparency at this point. One of the main drivers of this dynamic is that the majority of ETFs are passive vehicles that track a published underlying index (think SPY, QQQ, etc.), so there is no need to hide the portfolio of ‘ETF and related transactions. Additionally, the highly successful actively managed ETFs managed by Cathie Wood at ARK Investments are also fully transparent, as are many recent thematic ETF launches by companies such as Global-X.

However, many active portfolio managers who currently use the mutual fund wrapper are not comfortable with full daily portfolio transparency and therefore are interested in the semi-transparent structure of ETFs. Positive winds expected to drive this growth are conversions from actively managed mutual funds to ETFs and the desire for active ETFs over traditional mutual funds by millennials and millennials.

To date, 41 semi-transparent actively managed ETFs have been launched, with more than $ 2.1 billion in assets under management, and industry watchers expect many more launches by 2022 and beyond. -of the. In contrast, the market for active mutual funds (stocks and debt) sits at around $ 10 trillion, so there is plenty of room for growth, as evidenced by the growing pipeline of active fund managers who have announced their intention to issue strategies inside the Semi-Transparent ETF Envelope. Expect to see more products, giving investment advisors more choices in new and differentiated active management strategies for investors.

What are the main benefits of these envelopes for a registered investment advisor and their clients? First, semi-transparent ETFs open up a new avenue of exchange traded investment, exploiting proprietary active strategies that until now have only been available in mutual funds, SMAs, and other wrapper structures. Second, investors benefit from lower costs for these products; Typically, these ETFs are always priced lower than the comparable mutual fund strategy (so important to Reg BI and other fiduciary considerations). Third, because it is an ETF, investors can trade through their regular brokerage account and get immediate liquidity since they are traded on an exchange.

And fourth, they are very tax-efficient structures compared to traditional mutual funds thanks to an ETF feature known as personalized baskets. Most actively managed fully transparent ETFs use the custom basket feature to eliminate capital gains at the fund level, thereby preserving the returns on the fund’s investments and eliminating the obligation to distribute accumulated capital gains to clients. However, it’s important to know that not all semi-transparent packaging benefits from SEC Custom Basket Relief, which potentially limits their ability to be very tax-efficient. Note that the Blue Tractor packaging has SEC custom basket relief, so funds using that packaging are as tax-efficient as they would with fully transparent ETF packaging.

So how do you determine if a newly launched actively managed ETF is semi-transparent? Just check out the ETF and ISC fact sheet; semi-transparent ETFs have clear and simple English risk disclosure language.

And also note that currently the SEC restricts portfolio managers using the semi-transparent ETF envelope to primarily domestic listed equity securities and futures. These ETFs are prohibited from investing in fixed income securities, securities from Europe, Asia, etc. and use derivative instruments, including options. Many industry observers believe that portfolio managers’ use of semi-transparent ETFs will gain momentum once these investment universe limits are lifted by the SEC.

All recently launched semi-transparent ETFs are available on major clearing platforms; Schwab, Fidelity and Pershing and certain RIAs and independent brokers allow their advisers to place clients in these products; But each RIA and broker will still need to approve individual funds on a case-by-case basis depending on their company’s due diligence hurdles, comfort level with the fund’s strategy, track record, etc. – transparent ETFs for their clients; However, it is widely predicted that this will change in the not-so-distant future as these large companies complete their due diligence on this new category of ETF envelopes.

Let’s finish with a concrete example of a portfolio manager using the semi-transparent Blue Tractor envelope to launch an exclusive active strategy. In mid-February 2021, SS&C ALPS Advisors launched a focused and actively managed real estate investment trust strategy on the Nasdaq Exchange (ticker: REIT) which has returned 16% since inception. Trading spreads for REITs have been excellent – as low as a dime wide on some days – meaning investors can buy and sell these funds at prices very close to their underlying net asset value, ensuring an experience. consistent customer. Learn more at https://www.alpsfunds.com/products/etf/REIT.

The reality is, at the end of the day, investment advisers don’t really need to worry about the structural details of all semi-transparent packaging. Advisors can rest assured that they are doing what they claim to do, as the SEC has authorized them and the clearing platforms have approved the underlying structure and strategy of the fund. What ultimately matters of course to an investment advisor and his clients is the performance of the active fund manager and his ability to generate alpha.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.