The popularity of active ETFs continues to grow as investors of all sizes look towards the structure to gain additional returns and meet their portfolio goals. However, the adoption of active ETFs – like many new investment vehicles and assets – isn’t always smooth sailing. Wirehouses, brokerages and other financial advising groups often place limits or restrictions on various new asset classes until further research is done. This has been the case for the world of non-transparent active ETFs.
But the ice may be beginning to thaw.
Morgan Stanley recently unveiled some new changes to its policies for advisors regarding non-transparent ETFs. Given Morgan Stanley’s size within the brokerage and financial advising community, it could be the boon non-transparent ETFs are waiting for.
See our Active ETFs Channel to learn more about this investment vehicle and its suitability for your portfolio.
A Quick Primer on Active ETF Structure
Minus a few commodity and specialized funds, most ETFs built using rules under the Investment Company Act of 1940. The SEC has granted ETFs some wiggle room with regards to the act, including the ability to only sell shares to large authorized participants (APs) rather than directly to investors.
Another big difference (and exception) comes down to disclosure of underlying assets.
Historically, ETFs – whether passive or active – have been required to disclose holdings every day. This was done to allow APs and market-makers the ability to trade the blocks of assets at fair prices. However, this daily disclosure runs afoul of front-running issues. It’s not a big deal when we’re talking about the S&P 500, but if you happen to be an active manager wanting to keep your secret spice mix hidden? It’s a huge issue.
To that end, fund sponsors began exploring ways to skirt the disclosure rules and keep what’s hidden, well, hidden. The SEC listened and started to approve various semi-transparent structures and rulings that provide relief of the Investment Company Act of 1940. For example, the Precidian ActiveShares model uses a series of middlemen to prevent anyone knowing what’s actually in the fund. Precidian isn’t alone – with Blue Tractor, the New York Stock Exchange, Fidelity, T. Rowe Price and Natixis Investment each having different ways of doing the same thing.
In the fund industry, these structures have been dubbed semi-transparent or non-transparent ETFs.
The problem is, just because something exists doesn’t mean people will use it. In the case of non-transparent ETFs, various wirehouses, brokerages and large financial planning groups have been reluctant to adopt the structure. From bid-ask spread issues and worries about disclosure to a lack of revenue sharing for their platforms and inability to lend shares, non-transparent ETFs have been verboten from their platforms.
Morgan Stanley Sets the Wheels in Motion
With nearly $6.5 trillion in client assets, and $4.9 trillion of that in wealth management/advising assets, Morgan Stanley is no slouch when it comes to the financial planning community. As reported by Ignites, MS will now allow its wealth management financial advisors to begin using active non-transparent ETFs in their portfolio allocations and in conversations with clients. UBS was the first to offer such ability, but the bank is more focused on Asia and Europe than domestically. Moreover, UBS only allows its brokers access to two non-transparent active ETFs.
Given Morgan Stanley’s size and network of advisors, the announcement is pretty significant for the non-transparent ETF movement. Fund sponsors have cited a lack of use for the structure as one of the major inhibitors of growth. Right now, there are only about 50 non-transparent active ETFs covering only ~$5 billion in assets. And more than half of that sits in the Nuveen Growth Opportunities ETF (NUGO).
The reality is, individual, self-directed investors don’t really have the muscle to determine product success or failure. It’s the wirehouses, advisors and institutional investors with significant assets that do so. With a potential $5 trillion moving into non-transparent active ETFs from Morgan Stanley, its decision isn’t one to be taken lightly and could set a fire under the adoption of the structure. We have the stamp of approval of a very big advising network that has a large asset base, which is something that has been missing from non-transparent active ETFs.
With Morgan Stanley jumping onboard, more advising and wirehouse groups could soon join them. Shortly after Morgan Stanley made its announcement, rival Merrill Lynch reported that it has added select non-transparent active ETFs to its various wealth management, robo-advisor and Merrill Edge brokerage platforms. Wells Fargo is the only hold-out of the main wirehouse brokers.
With the dominos starting to fall, non-transparent active ETF adoption could skyrocket and become a normal part of our portfolios.
The Bottom Line
Adoption of non-transparent active ETFs has been stuck in neutral for some time. The main reason has been a lack of support from the wirehouse, wealth management and brokerage communities. But with Morgan Stanley’s decision to start allowing its advisors access to the ETFs, the game could be changing. Assets should grow, and the promise of non-transparent active ETFs could finally be realized.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.
