Semi-Transparent ETFs Are Dead? Time to Change the Narrative

Over the summer we’ve seen articles in the financial press with headlines like “Semi-Transparent ETFs are Dead” and media comments from so-called ETF industry experts and pundits that the semi-transparent space isn’t growing because investors aren’t interested in these products. Further confirmatory proof these experts and pundits claim is that all the active mutual funds to date that have converted into ETFs are choosing to use the fully transparent wrapper.

At Blue Tractor we believe these observations are off the mark. 

While its accurate to say that the high growth expectations the ETF industry had for the semi-transparent space have not yet been met (in terms of the number of products launched and their total AUM), this malaise we believe stems from friction affecting the space that could be readily solved.

The number one friction the semi-transparent space faces are that the SEC limits the investable universe available to an investment manager to essentially long-only domestic equities – that’s it! If an active investment manager seeks their edge in Europe, Asia or other emerging markets or aims to enhance alpha using options or leverage or wants to invest in fixed income instruments for yield, they can only at this time use the fully transparent ETF wrapper. The SEC has handcuffed an entire swathe of active managers, both traditional and alternative investors, who does not wish to play solely in the plain vanilla domestic equity market. And the mutual fund conversions we see often include strategies employing options, foreign equities and fixed income; so straight out of the gate they’re precluded from considering the semi-transparent route. It’s time for regulators to give investment managers unfettered access to the semi-transparent ETF wrapper for all asset classes and investment strategies; let investment managers decide when to go semi-transparent versus fully transparent and not the government.

Look at Canada and Australia, where actively managed ETFs using what is termed “delayed portfolio disclosure” have existed for years (i.e., they are operating essentially like the semi-transparent ETF market in the U.S.). In Canada and Australia, the local regulatory bodies do not restrict these ETFs to only invest in domestic equities.

Second, the U.S. ETF distribution model is sclerotic. Legacy gatekeepers control access to the majority of RIAs and therefore client AUM. If an investment advisor can’t get their ETFs on the approved list at the wire houses, independent broker dealers or other custodial platforms then capturing flows and AUM is severely handicapped. Well guess what? Many of the broker dealer still haven’t approved the semi-transparent ETF structures, be it as individual ETFs or as one component in a model portfolio offering, despite these wrappers now having been market-proven for 2 to 3 years and exhibiting excellent capital markets trading performance. Fortunately, there’s good news in that the majority of the wire houses have approved the semi-transparent wrappers; so what’s it going to take for the independents and platforms to roll up their sleeves and get the approvals done? Many are hung up on the ‘chicken and egg’ analogy; they won’t approve semi-transparent ETFs because AUM for this sector remains low. Yet, without access to RIAs its difficult to raise AUM!

The negative energy from the experts and pundits surrounding semi-transparent ETFs is anchored in the implicit assumption that investors only want fully transparent ETF products. Afterall the experts and pundits say, the ETF market is rooted in passive index products that are fully transparent, so why should actively managed products be any different. This is a specious argument – retail investors generally don’t know, don’t understand and frankly don’t care – what their ETF wrapper type is. If they are buying an actively managed ETF they are seeking to capture alpha, so performance trumps everything. 

And a secondary assumption the experts and pundits make is that full transparency in an ETF is the only route to success for an investment manager to attract assets into their fund. Except that the numbers don’t back that up; recent ETF.com figures reveal that up to the middle of July 2023 there were 148 ETFs shuttered – all of them fully transparent! That’s right; not one semi-transparent ETF has closed in 2023. And Bloomberg reports that on average annually 110 ETFs – all fully transparent – liquidated over the period 2016 through 2022, peaking at 182 in 2020. [1]

But to be fair, in December 2022 one semi-transparent ETF did convert into a fully transparent ETF. Franklin Templeton elected to convert an actively managed semi-transparent ESG ETF (CFCV) to fully transparent in the hope that it could garner improved distribution and flows. When Franklin Templeton announced their plans to convert, AUM for CFCV stood at $3.2 million. So how did the move to full transparency work out for Franklin Templeton? Eight months later, as at early August 2023, AUM for CFCV stands at $3.2 million. [2]

In closing, we’d like to draw your attention to Nasdaq: DYTA, an actively managed tactical allocation fund of funds ETF (i.e., an ETF that invests in other ETFs) issued at the end of March 2023 by Summit Global Investments, an independent RIA and wealth manager based in Utah. DYTA utilizes the Blue Tractor semi-transparent wrapper technology and at inception had approximately $2 million of AUM. Fast forward just four months and as of the date of this paper DYTA sits at about $110 million – an astounding 5,500% increase in flows into the ETF. Proof in the pudding, as they say, that a semi-transparent ETF can and will attract RIA and investor interest when it’s the right active strategy at the right time.

[1] https://www.etf.com/etf-closures

[2] https://finance.yahoo.com/news/franklin-templeton-esg-etf-goes-173000630.html

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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