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As of last August, actively managed mutual funds held assets of $11.8 trillion—more than triple the $3.6 trillion held by passively managed index funds. Conversely, though, the $61.9 billion in assets held by actively managed exchange-traded funds (ETFs) represents around 2 percent of the total amount of assets held by passive ETFs. However, with the SEC's recent approval of the first non-transparent ETF structure, the active versus passive disparity for ETFs with respect to assets under management may be in for a big shift.

One hallmark of ETFs is their transparency, which is accomplished in part through daily disclosure of each ETF's investment positions. But for active managers, the frequency of the ETF-disclosure regime leaves many feeling exposed to frontrunners aiming to predict the active manager's next move. This has led to many active managers steering clear of ETFs altogether (as the numbers above exhibit); however, this may begin to change, as the SEC issued a notice to Precidian granting exemption under the Investment Company Act of 1940, effectively allowing the company's plan to create a "non-transparent ETF" structure (which Precidian is calling ActiveShares) to go forward.

The plan for Precidian's ActiveShares would have them disclose the ETF's holdings once per quarter, much like a mutual fund. But Precidian will also calculate and disseminate the intraday indicative value of its non-transparent ETFs every second to help ensure that the price stays in line with the value of the underlying assets. ActiveShares will also use agents who can see the funds' holdings to help move cash in and out. These agents would be subject to a duty of nondisclosure. Moreover, as a condition for approving the novel structure, Precidian must highlight several key disclosures to potential investors: that due to the limited transparency in the portfolio, there may be an increase in bid-ask spreads or the ETF's shares may trade at a premium or discount to its net asset value; and that market participants could, in the end, still try to reverse engineer the ETF's strategies on trading. Precidian must also include a legend on the outside cover of the ETF's prospectus highlighting the differences between their new ETF structure and the traditional ETF structure.

The ActiveShares structure has already seen a large amount of interest among active managers from large, well-known global asset managers and fund families who wish to license Precidian's ActiveShares structure. Analysts, on the other hand, have mixed opinions on whether this new type of ETF will be popular among investors. Eric Balchunas, an ETF analyst at Bloomberg Intelligence, notes that "[t]ransparency…is in the top five most beloved traits of ETFs—this [structure] challenges it." Other analysts have noted, however, that aside from protection against front running—the impact of which is also debated by commentators in the financial industry—the main benefit for investors is more options for actively managed funds in what amounts to an ETF structure. In other words, an actively managed investment that does not produce capital gains distributions, 12b-1 fees, or performance drag when portfolio managers sit on cash to meet redemptions. As a consequence of using the ActiveShares structure, it appears likely that non-transparent ETFs will have an appreciably lower total cost than the average actively managed mutual fund—a position that should be enticing to at least some investors.

With the news that the SEC granted an exemption to Precidian for their ActiveShares structure, many other financial service companies, including Fidelity, Blue Tractor Group, and T. Rowe Price, filed their own variations of the non-transparent ETF structure. For example, Blue Tractor Group's proposal would have their non-transparent ETF reveal all of the fund's holdings but scramble the weight of each individual holding. Assuming the SEC grants exemptions for these new structures of non-transparent ETFs, it will be interesting to see whether all of these new non-transparent ETFs will be able to drive a significant amount of money into this novel investing niche, or rather, whether investors will continue unabated to use transparent ETFs with virtually no disruption from non-transparent ETFs. Regardless of the answer, what is certain is that many new actively managed, non-transparent ETFs will be coming to an exchange near you as soon as this fall.

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