The Vexing, Active ETF Standoff Between Advisors and Asset Managers

Active management is coming into vogue again but a disagreement about transparency is hampering the active ETF market.

(Illustration by RIA Intel)

(Illustration by RIA Intel)

Financial advisors might not be able to have their cake and eat it, too.

The outlook for markets seems less rosy, giving a boost to active management, which is coming into vogue again. Advisors are looking to actively-managed funds, hoping to better prepare client portfolios for a potential downtown after the longest bull market in history. But this time around, more are turning to actively-managed exchange-traded funds and finding themselves in a vexing position.

There just aren’t that many actively-managed ETFs and an ongoing disagreement between advisors and asset managers about their transparency is keeping that number low.

At the end of 2018, there were 1,660 index-based ETFs with $3.2 trillion in assets, compared to fewer than 300 actively-managed ETFs with less than $100 billion, according to a recent report by Cerulli Associates.

Advisors like that ETFs must report their daily holdings but asset managers have effectively zero interest in doing that. It’s a true standoff.

“The major obstacle for many active managers considering entering the active ETF space is the requirement to disclose portfolio holdings on a daily basis. Most active managers do not have an appetite for disclosing holdings more frequently due to their concern for frontrunning, which could lead to less favorable portfolio implementation when establishing or exiting a position in a given security,” according to Cerulli.

For that reason, the majority of actively-managed ETFs that exist have fixed-income strategies that are harder to replicate from publicly disclosed holdings.

Regulatory changes regarding non-transparent ETFs, which would not be required to disclose their holdings daily, are being considered and could change the landscape in the coming years. But for now, either advisors or asset managers will have to bend to the other.

Still, actively-managed ETFs are not totally on ice. In fact, the number in development is ramping up relative to the number of passive strategies, according to Cerulli. Most ETF issuers (78%) are currently developing or planning to develop active ETFs.

There are other growth drivers, beyond investors seeking active strategies. The reality is that competing against a short list of gargantuan asset managers on cheap, passive ETFs is difficult. “Few managers can compete in a meaningful way due to the sheer scale of the top firms in the space (Vanguard, BlackRock, State Street),” the report states.

Competing on actively-managed ETFs is more accomplishable and advisors may come around.

“Although many active managers have experienced challenges adding alpha in a market environment that favors passive strategies, active strategies remain the largest portfolio allocations for most advisors. As such, there is an opportunity for issuers to offer active strategies in an ETF vehicle, with lower cost, greater tax efficiency than active mutual funds, and intra-day liquidity.”

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