How can active asset managers distribute their strategies in ETFs?

The opportunity to offer non-transparent ETFs is highly attractive and lucrative, particularly for active managers amid an industry-wide shift toward low-cost passive investments.

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Key Implications

  • Almost half of issuers state that they are either currently developing (20%) or planning to develop (27%) non-transparent active ETF products.
  • Asset managers will have to decide whether their newly launched products should be clones, differentiated versions, or entirely different products when compared to their existing offerings.
  • Given additional costs of licensing fees and revenue sharing, it will not be easy for active managers to offer attractive pricing on their non-transparent ETF products, which Cerulli believes is critical to their success.


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Develop a Non-Transparent Active ETF

In a watershed moment for the ETF industry, the first non-transparent active ETF structure was approved in May 2019. Even before the structure’s approval, issuers were reporting that passive product development was cooling, while active ETFs were becoming a growing focus. In a 2018 Cerulli survey, 22% of ETF issuers reported interest in developing vehicles in a non-transparent ETF structure—and the structure had not yet been approved. Cerulli’s 2019 survey of existing issuers further substantiates the shift toward active ETFs: almost half of issuers state that they are either currently developing (20%) or planning to develop (27%) non-transparent active ETF products, making for a momentous shift in a market where only approximately 2% of assets are currently actively managed.

ETF Issuers’ Plans to Develop Exchange-Traded Vehicles by Type, 2019 

Source: Cerulli Associates

Asset managers that offer active strategies are encouraged to evaluate the four non-transparent ETF structures that have both received regulatory approval and are seeking licensees (Precidian, BlueTractor, NYSE/Natixis, and Fidelity). The structures will likely charge 3 to 5 basis points of underlying assets, and differ mainly in what they disclose (intraday pricing, if any is offered, and the types of holdings held out as representative for the proxy portfolio approaches). Asset managers should carefully gauge whether the structures can support their strategies, and whether the disclosures provided by each will be enough to facilitate efficient trading.

Key Factors in a Launch

In discussing the potential for asset managers to find success in launching products via active non-transparent structures, Cerulli encounters significant polarization across the industry. Many asset managers believe that they will be able to successfully distribute their products via the structures, taking advantage of the tax efficiency of the ETF vehicle while hopefully targeting clients in new channels. Other industry participants are significantly less optimistic—with their concerns outlined below. Cerulli notes that none of these is insurmountable.



 


Product Choice


Cerulli believes that of the listed challenges, product choice may be the most significant one to be overcome. Assuming that the non-transparent structures and associated infrastructure are found to be capable of supporting their strategies, asset managers will have to decide whether their newly launched products should be clones, differentiated versions, or entirely different products when compared to their existing offerings. The decision will be impacted by concerns of over-saturating distribution partners and cannibalization of existing products.

At issue is whether due diligence home offices will approve products that are the identical in both the mutual fund and ETF wrappers (potentially creating a compliance challenge). Product executives caution Cerulli from taking a too simplistic view of home-office needs—suggesting that gatekeepers would have different approaches. One executive states that, “Some are resistant to clones but not others—we keep an internal checklist of where friction might be.”



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Cannibalization is a critical concern for firms with successful existing strategies, but several research participants explain that a segmentation of assets invested in existing funds suggests that these concerns may not be the roadblock initially feared. For example, retirement channel (e.g., 401(k) plan) assets are unlikely to transition into the ETF wrapper, which is not often used in that space, while advisors are still likely to continue to use mutual funds in tax-advantaged accounts.

When Cerulli polled issuers on the AUM level they expected non-transparent products to reach by 2025, 80% report that they believe that the market opportunity is between $1 billion and $100 billion—underscoring that existing issuers (some of whom are likely to launch such products) are well aware of the challenges that the vehicles will face and perceive that this as a long-term growth opportunity dependent on extensive product development.

ETF Issuers: Estimate of Non-Transparent/Semi-Transparent Potential AUM by 2025, 2019 

Source: Cerulli Associates

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Pricing


Beyond product selection, pricing the products is a heavy lift for active managers. ETF allocators are used to cost savings being associated with the ETFs, but one research participant built a case for charging even more given their improved tax efficiency. The reliance on a licensed structure will add to the cost associated with the product while the lack of sub-transfer agency fees provides some savings. However, a third component to product pricing is revenue sharing. Luckily, existing active managers are likely experts at navigating revenue-sharing considerations and ensuring their distribution partners are satisfied.

It’s also important that asset managers help broker/dealers manage conflicts—for example, a non-transparent active ETF priced identically to a mutual fund may be a less efficient holding, especially considering the wider bid-ask spreads that may come with non-transparent ETF structures.

Given the referenced additional costs of licensing fees and revenue sharing, it will not be easy for active managers to offer attractive pricing on their non-transparent ETF products, which Cerulli believes is critical to their success. Cerulli cautions active managers to respect the scale of fee compression in the ETF landscape and not over-rely on the ability of their brand and distribution forces to drive sales of the products.

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