Why the Biggest Asset Managers are Chasing Active ETFs

Major financial players including JPMorgan Chase & Co. (JPM), Legg Mason Inc. and Capital Group Cos. plan to debut an emerging breed of exchange traded funds (ETFs), called active ETFs, that could dramatically reshape the industry. This effort by traditional stock pickers to attract client funds comes as investors flock to cheaper, passively managed products tied to indexes, as outlined by the Wall Street Journal. Skeptics cite lack of transparency as a key issue that may hurt the growth of these investment vehicles, but new “Shielded Alpha” ETFs may partly solve the problem. 

Earlier this year, Precidian Investments received regulatory approval for the active ETF design. Unlike traditional transparent ETFs, these active ETFs, with the first set to debut by year-end, do not need to disclose investments each day. Instead, active ETFs are designed to release their updated positions on a quarterly basis, much life mutual funds. This prevents front-running of trades. This is why Jim Tambone, the chief distribution officer at Alger, an investment firm with ties to Precidian, calls active ETFs a “game changer” for the industry.

But Tambone’s confidence doesn’t ensure success. Other investors are developing a new kind of active ETF that will be more transparent than the one designed by Precidian. The so-called “Shielded Alpha” ETF structure would make active ETFs more transparent and more attractive, as outlined by Barron’s. “Transparency has been the linchpin of the success of the ETF market today,” said Simon Goulet, co-founder of Blue Tractor Group, a financial-technology firm that is seeking SEC approval for “Shielded Alpha.” Goulet adds, “Investors know what they’re getting and market makers and [ETF] authorized participants can understand the risks that they’re hedging when they create and redeem the basket of securities an ETF owns.” 

Active managers typically prefer to keep their investment decisions private so that rivals do not steal their ideas. That’s where a “Shielded Alpha” ETF breaches the gap between regular, transparent ETFs, and Precidian’s non-transparent, actively managed ETF. An ETF employing “Shielded Alpha” would be required to disclose its holdings daily to investors. The main difference between this model and other active ETFs, however, is that it would not disclose precise weightings. This would offer investors peace of mind to know what their investments hold, yet protect stock pickers from front running. 

This kind of more transparent, active ETFs may be key to attracting stock pickers and new money for these funds. But while these vehicles may make inroads in the market, they are unlikely to win back the billions of dollars lost to low-cost, passive ETFs.