Head of U.S. ETF Capital Markets
Active ETFs are far more transparent than mutual funds
Passive ETFs were first launched several decades ago and still account for the majority of assets under management in ETFs. Investors in passive ETFs know exactly what they own because the holdings are similar to the index being tracked and because issuers publish full holdings daily. Even as passive ETFs have evolved to track more customized indices or baskets, they remain completely transparent.
While transparency has been a convenient benefit for investors in passive ETFs, it has been transformational in the age of active ETFs. Previously, investors had essentially two options for owning an actively managed diversified investment portfolio: individual securities in a brokerage account or shares in a mutual fund. Owning individual securities offers full transparency but a lot of portfolio management complexity; owning shares in a mutual fund offers ease and convenience at the expense of transparency.
For example, mutual funds are currently required to disclose their monthly portfolio holdings on a quarterly basis, 60 days after the end of the quarter, with the third month in the quarter made public by the Securities and Exchange Commission (SEC). While many mutual funds disclose their holdings much more frequently, such as monthly with a 30-day lag, this is still no match for the daily full disclosure of current holdings offered by active ETFs.
Knowing what you own helps manage risk
The significantly greater transparency of ETFs is particularly beneficial for investors in active ETFs when compared to mutual funds with similar investment strategies. For example, knowing exactly which securities are in a given ETF enables better overall portfolio construction and risk management for individual investors, advisors or institutional investors through daily performance information and attribution. Investors can also research an ETF and view how holdings have changed over time or how the ETF's performance aligns with its investment objectives.
ETF transparency offers clear benefits to investors in terms of understanding what they own, constructing a portfolio and managing risk; it also improves ETF trading, liquidity and market making, which ultimately further benefits investors.
Traders and market makers can access the full holdings of any ETF through the daily disclosure, which allows them to accurately price an ETF based on its underlying assets. This transparency reduces the likelihood of mispricing, leads to tighter bid/offer spreads and improves liquidity. All of these factors contribute to better pricing during market stress, an important benefit for investors.
Easy access to full daily disclosure
In the U.S., ETFs are regulated by the SEC, which provides requirements and guidance for disclosures. Passive and active ETFs must provide full daily portfolio disclosures that are generally published in the evening. Market participants can access the full holdings via issuer websites, Bloomberg and other data vendors. Some ETF market participants may also receive composition files directly from ETF issuers.
Semi-transparent ETFs help bring more active ETF strategies to market
Daily disclosure can be a disadvantage for some actively managed funds because it may reveal proprietary investment strategies to competitors, potentially leading to front-running or copycat investing. Therefore, an exception to full transparency exists.
Semi-transparent ETFs allow fund managers to keep their precise holdings confidential, while still providing enough information for market makers to effectively price and trade the ETF shares. Typically, the portfolio managers will use a proxy portfolio, which is a set of securities constructed to closely track the performance of the actual portfolio without revealing its exact composition. The proxy portfolio serves as a comparable stand-in for the real holdings so that market makers can price and trade the ETF shares. Investors and market participants have enough information to understand the general investment strategy and risk profile of the ETF, but do not have the specific securities or their exact weightings in the actual portfolio. The proxy portfolio protects the proprietary strategies of active fund managers by preventing competitors from copying or front-running their trades.
The landscape for semi-transparent ETFs is evolving. The SEC has approved several models for these funds, which has led to increased interest in the semi-transparent ETF market. At the same time, as products are created and traded, market makers have become increasingly comfortable pricing and trading these ETFs.
The trend of transparency
As a dedicated active manager, J.P. Morgan Asset Management offers active ETFs ranging from enhanced index strategies to highly active approaches. Our active ETFs are transparent, as our portfolio managers are comfortable with this approach and our clients value this attribute.
Semi-transparent ETFs provide a helpful solution when clients prefer to access a strategy through an ETF vehicle, but the portfolio manager believes full transparency may impact the ability to generate alpha.
We expect that most of the active ETFs we launch in the future will continue the trend of transparency and that semi-transparent ETFs will remain a relatively small part of the market.