The ETF revolution reaches active ETFs
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D.J. TIERNEY: 2020 was an extraordinary year. We all learned to adapt to a global pandemic and volatile markets, but amidst those challenges, a positive change for ETFs emerged. In 2020, the first active semi-transparent ETFs, also known as non-transparent ETFs were launched. This new kind of ETF was approved by the US Securities and Exchange Commission, or SEC, in 2019. Today, there are more than 40 active semi-transparent ETFs in the market, with over $5 billion in assets under management.
ETFs have been around for almost 30 years, so why this new kind of ETF? Well, the traditional benefits of ETFs, such as trading during market hours, potential tax efficiency, and low cost could be attractive to you and your clients. Investors and advisors increasingly want those benefits, with alpha generating potential. But pre-2019 SEC rules required daily portfolio disclosures, which presented a challenge for portfolio managers and created a barrier for the creation of active ETFs.
There are very good reasons why an active portfolio manager wouldn’t want to share their portfolio holdings every day. It can sometimes take more than a day to implement portfolio changes, and sharing the details of the portfolio so frequently can make it too easy for competitors to seek to profit on those changes.
In active semi-transparent ETFs, the feature of cloaking, or not sharing the whole portfolio every day, is what makes them different from other traditional ETFs. Through active semi-transparent ETFs, portfolio managers can make changes to their portfolio without outside interference and more active managers can adopt this kind of product.
If you or your clients have interest in learning more about this structure, we’ve written an article called An Introduction to Actively Managed Semi-Transparent ETFs.
So how can active semitransparent ETFs help you? More choices and more competition can help advisors and investors. Adding active semi-transparent ETFs to a foundation of indexed ETFs can help you and your clients diversify portfolios and pursue different goals.
For example, some active semi-transparent ETFs seek to lose less than an underlying index, which can potentially smooth returns when markets are volatile. Others may better align portfolios with environmental or social values. There may also be compelling opportunities for active management in less efficient corners of the equity market, like small cap stocks.
And while there may be many benefits to adding active semi-transparent ETFs to portfolios, you and your clients should also be aware of their unique risks. For example, it may be more difficult to accurately value the underlying holdings, resulting in higher bid-ask spreads and thus higher trading costs than traditional indexed ETFs. We’ve written an article called Understanding the Risks of Actively Managed ETFs for you to learn more about trading costs and other various risks.
ETFs continue to revolutionize how you and your clients can access investment strategies. It is an exciting time to build diversified portfolios with ETFs.
I hope you found this video helpful. For a more in-depth look, our team at Schwab Asset Management has written articles that explain more about active semi-transparent ETFs and what to consider when adding them to client portfolios and understanding their risks. Thank you for watching.
Amidst a global pandemic and volatile markets, active semi-transparent ETFs (also known as non-transparent ETFs) emerged. Learn more about this new kind of ETF and how it can help you and your clients diversify portfolios and pursue different goals.
Alpha is a measure of fund performance. Alpha compares the performance of a fund to a benchmark index (such as the S&P 500). The excess return of the fund relative to the return of the benchmark index is a fund’s alpha. A positive alpha means the fund has outperformed the index.
What makes the Schwab Ariel ESG ETF different from traditional ETFs?
Traditional ETFs tell the public what assets they hold each day. This fund will not. This may create additional risks for your investment. For example:
- You may have to pay more money to trade the fund’s shares. This fund will provide less information to traders, who tend to charge more for trades when they have less information.
- The price you pay to buy fund shares on an exchange may not match the value of the fund’s portfolio. The same is true when you sell shares. These price differences may be greater for this fund compared to other ETFs because it provides less information to traders.
- These additional risks may be even greater in bad or uncertain market conditions.
- The ETF will publish on its website each day a “Proxy Portfolio” designed to help trading in shares of the ETF. While the Proxy Portfolio includes some of the ETF’s holdings, it is not the ETF’s actual portfolio.
The differences between this fund and other ETFs may also have advantages. By keeping certain information about the fund secret, this fund may face less risk that other traders can predict or copy its investment strategy. This may improve the fund’s performance. If other traders are able to copy or predict the fund’s investment strategy, however, this may hurt the fund’s performance.
For additional information regarding the unique attributes and risks of the fund, see Proxy Portfolio Risk, Premium/Discount Risk, Trading Halt Risk, Authorized Participant Concentration Risk, Tracking Error Risk and Shares of the Fund May Trade at Prices Other Than NAV in the Principal Risks and Proxy Portfolio and Proxy Overlap sections of the prospectus and/or the Statement of Additional Information.