Oct 8, 2020

DealBook: A New Kind of Fund That Is Stingier With Information


Norm Alster

Mutual Funds|A New Kind of Fund That Is Stingier With Information

Once, exchange-traded funds all tried to mirror the market. Now some are trying to beat it, in some cases by concealing their day-to-day trades.

Credit...Sasha Maslov for The New York Time

A new kind of fund has entered the marketplace. Whether it is better than its predecessors remains to be seen.

The new entrant is known as a nontransparent actively managed exchange-traded fund. That mouthful sounds like a self-contradictory term — an oxymoron, really — but 16 nontransparent active E.T.F.s are already being sold, according to Elisabeth Kashner, vice president and director of E.T.F. research at FactSet.

What are they exactly? Let’s define terms.

Exchange-traded funds, which may be bought or sold all day like stocks, started as index funds — meaning, at relatively low cost, they mirrored the market and didn’t try to beat it. Actively managed funds, run by people who select individual stocks and bonds, were originally packaged only as traditional mutual funds, which can be bought or sold only once a day.

Attributes of those two main kinds of funds were combined more than a decade ago, with the advent of actively managed E.T.F.s. Now, there is a newer innovation: The Securities and Exchange Commission says some funds don’t have to disclose all of their holdings, making them “nontransparent.”

Is this cause for celebration? It may be for fund companies, which can avoid tipping their hand to the competition when they make trades. It’s too early to say for the vast majority of investors, who have not embraced the new nontransparent funds in a big way so far.

Actively managed mutual funds as a whole have underperformed their benchmark indexes for years. Whether active E.T.F.s, including the nontransparent kind, will do better remains to be seen.

Assets held in actively managed E.T.F.s of all varieties amount to $136 billion, according to FactSet. Of that total, nontransparent active E.T.F.s hold only about $730 million.

That compares with $4.8 trillion for all E.T.F.s, according to the Investment Company Institute, a trade group. Most E.T.F.s are basically index funds. Traditional stock and bond mutual funds still hold most fund assets — more than $18 trillion, according to the institute.

E.T.F. giants like BlackRock, State Street Global Advisors, Vanguard, Invesco and Fidelity all offer active E.T.F.s. And T. Rowe Price, which had not done so, is beginning to offer actively managed ones.

The JP Morgan Ultra-Short E.T.F. a short-term bond fund, leads all active E.T.F.s with $14 billion in assets under management, Ms. Kashner said. Its expense ratio is 0.18 percent. Other short-term bond E.T.F.s have expense ratios ranging from .08 percent to 0.42 percent, according to FactSet.

One active E.T.F. that has done especially well lately is the Ark Innovation E.T.F. which is focused on leaders in so-called disruptive technologies like robotics and artificial intelligence. It gained 83.8 percent this year through Sept. 30.

Tom Staudt, chief operating officer for Ark Invest, says its E.T.F. format provides “a cheaper way to have actively managed funds.” The fund’s expense ratio is 0.75 percent, according to Morningstar. That compares favorably with the average expense ratio of 1.16 percent for all midcap growth mutual funds.

The Ark fund reports its holdings daily, said Catherine Wood, the fund manager, making it highly transparent. Traditional mutual funds typically report holdings only quarterly. “Investors love transparency,” she said.

But nontransparent funds are useful for some fund companies. The new form of fund is intended to protect fund managers from competitors who might otherwise copy their holdings and front-run big trades that can only be executed gradually, said Todd Rosenbluth, senior director of E.T.F. and mutual fund research at CFRA, an independent research firm.

American Century Investments has issued four nontransparent — it calls them semitransparent — active E.T.F.s. Front-running was “theoretically a problem,” said Edward Rosenberg, head of E.T.F.s for the company. These American Century funds typically own just 30 to 60 stocks, and it sometimes takes days to amass a large position in each new holding, making it vulnerable to potential copy cats.

The mutual fund giant T. Rowe Price has also received S.E.C. approval to start four nontransparent active E.T.F.s. Tim Coyne, head of E.T.F.s for the company, said if T. Rowe Price had to disclose all of its trades daily, that information “could be used against us.” The motivation for less frequent reporting, he said, is “to protect our intellectual property.”

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