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'Confidential' ETFs could change the face of active management, industry leaders say

VIDEO4:0204:02
Non-transparent ETFs are here, but experts aren't sold on the concept

A new era of ETFs is here.

The Securities and Exchange Commission has started granting preliminary approvals for nontransparent exchange-traded funds, a move that could change the face of active investing, top industry minds say.

T. Rowe Price, Natixis, Fidelity and Blue Tractor were the first asset management firms to win preliminary approval for their ETFs. The new structure will allow them to run their funds without disclosing holdings on a daily basis, but instead on a quarterly basis, avoiding a common concern among active managers of being front-run on their strategies.

The development follows years of underperformance by active funds. As of June 30, just 21% of large actively managed funds outperformed the S&P 500 in the last five years, according to SPIVA, the "S&P Indices Versus Active" data-gathering project run by S&P Dow Jones Indices. The rest — nearly 79% — could not beat the benchmark average.

"[Of] the large-cap funds, just one out of three of those actively managed large-cap funds outperformed [the S&P] on a three-year basis," Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA, said Monday on CNBC's "ETF Edge."

"If you were hitting one out of three in baseball, you'd be in an all-star game. If you're doing it in a mutual fund world, you're seeing money flow out to ETFs. That trend is going to continue," Rosenbluth said. "The fees are just still too high for active management. They're struggling from a performance basis because of those high fees."

Because the added cost of running an actively managed mutual fund can seriously affect its sustainability, the chance to enter the ETF space and offer active strategies on the cheap is one managers likely won't pass up, said Tom Lydon, editor and proprietor of ETFTrends.com.

"We've got a lot of making up to do" on the active-management front, Lydon said in the same "ETF Edge" interview. "We've had a 10-year bull market. Passive has been on top. Will it ever revert to the mean where active comes back? If it does and these companies are betting on it in this ETF wrapper, especially because they've got a lot of marketing dollars behind it, I think that there's a way for them to get some flows."

It'll all come down to choice, Lydon said, echoing an idea put forth in the same interview by Invesco's Dan Draper, the firm's global head of ETFs.

"When you look at the $8.6 trillion that's in equity mutual funds, we know 4.6 trillion is passive, 4 trillion is active," Lydon said. "There's a lot of money, there's a lot of shareholders and there are a lot of long-term relationships there where these companies like T. Rowe Price, like Fidelity, want to say, 'Hey, we'll offer this to you in a mutual-fund format or an ETF format.'"

Draper added that from his experience at a top ETF issuer, the active-passive battle isn't as one-sided as some might think.

"At Invesco, we see most of our clients, and certainly new ones, are buying passive, but active as well," he said in the Monday interview. "So, I think the shakeout is continuing. Those closet indexers who are charging active prices, that's what's really being shaken out right now. But true active security selection is going to be with us in some form for a long time."

That's why Invesco will continue to offer various types to its clients largely regardless of demand, Draper said.

"Our approach at Invesco is to offer all the different types of potential solutions to clients. So, I'd say, in today's world, do we see huge, pent-up demand? Probably not today, but I think the potential to take the very best of active management security selection [and put] it into, at times, a more tax-efficient wrapper, potentially at some lower cost as well, I think for some clients, it could really make sense," he said.

"Specifically here, the approvals [are] coming in first for U.S. equities," Draper said. "But the potential for other asset classes like fixed-income nontransparent active [management is there]. So, it's a very important development, but I think the education and rollout will take time."

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Investors pass on active management. Experts talk what could be next
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Key Points
  • The SEC grants preliminary approval for nontransparent ETFs that don't require daily disclosure of their positions.
  • Regulators say they plan to approve such funds from T. Rowe Price, Natixis, Fidelity and Blue Tractor.
  • Active managers have shied away from the booming ETF industry for years because the transparent vehicle would give away their best ideas and expose them to front-running.