Don’t Write Off Semi-Transparent Active ETFs Just Yet


It’s probably still too soon to dismiss their potential in the evolving financial landscape.


The recent article in the Financial Times, “Secretive exchange-traded funds that hide what they are holding from potential investors appear to be falling out of favour,” really got me thinking.

As a passive investor who predominately holds index funds, I agreed with some of its points and observations, but also disagreed with others.

While it’s packed with data and quotes from the big names in the industry, it doesn’t quite capture the whole story of semi-transparent active ETFs. The piece harps on about the stalling growth and how these funds seem to be on a downward spiral.

And yes, it’s hard to ignore statements like “Semi-transparent ETFs are dead.”

But let’s not rush to conclusions. Aren’t we being a tad too quick to write off an entire category of financial instruments a mere few years into their debut? Financial innovations, especially ones that break from tradition, often need time to find their footing with refinements along the way.

Sure, they haven’t exploded onto the scene as some might have hoped, but it’s a bit early to label them a dud. Besides, isn’t the market big enough for both fully transparent and semi-transparent ETFs? Each has its place and purpose. Let’s not forget that.

Here’s why I think we (investors, advisors, and industry professionals alike) should give semi-transparent active ETFs another chance.

A brief recap of semi-transparent active ETFs

ETFs have been available to the U.S. market since the debut of the SPDR S&P 500 ETF (SPY) in January 1993, providing investors with a hybrid between individual stocks and mutual funds.

Traditional ETFs offer full transparency, revealing their complete portfolio holdings daily. However, as the financial world evolved, a new kind of ETF was conceived, one catering to active managers concerned about revealing their strategies.

Historically, many active managers hesitated to dive into the ETF market due to fears of exposing their proprietary strategies. For these managers, a list of daily holdings available to the public could put them at risk of front-running, or intellectual property infringement from a rival trying to replicate their portfolio.

This led to the birth of semi-transparent active ETFs. In 2019, U.S. regulators gave the green light to these semi-transparent ETFs, marking a significant departure from the conventional fully transparent model.

With semi-transparent ETFs, these fears are addressed. These funds can choose to disclose their holdings more infrequently, usually on a quarterly basis, akin to many mutual funds. Some might reveal what securities they hold daily via a proxy portfolio.

The semi-transparent structure still has some key advantages

The slowed accrual of assets for semi-transparent ETFs in comparison to the takeoff of their transparent counterparts doesn’t necessarily signal a bleak future. The semi-transparent structure holds unique advantages that are worth unpacking.

One significant advantage lies in providing exposure to active strategies in less liquid markets, such as a small-cap value strategy. Small-cap stocks, by nature, are more susceptible to market manipulation and price volatility. When an active manager identifies a golden opportunity in this niche, divulging every move in real time can expose the fund to undue risks.

Front-running, where other players in the market anticipate and leverage a fund’s trades, can be a real concern. Moreover, the threat of competitors replicating a strategy is ever-present. Semi-transparent ETFs shield the daily activities, offering a protective barrier against such pitfalls.

While in more liquid markets this protective layer might seem superfluous, in these narrower segments, it emerges as an invaluable asset. This unique characteristic allows investors a chance to dip into strategies they might otherwise only encounter in pricier mutual fund offerings.

Consider the JPMorgan Active Small Cap Value ETF (JPSV), which for a 0.74% expense ratio offers active management in the small-cap value space different from the usual plethora of index-based and rules-based, transparent factor/smart-beta ETFs commonly used.

Another compelling advantage is the opportunity these ETFs offer to legacy mutual fund firms. As the ETF space expands, mutual fund providers confront an adapt-or-perish scenario, but breaking into the ETF domain isn’t straightforward.

The hallmark transparency of most ETFs can be daunting, particularly for companies that have honed specific active strategies over the years. This is where the semi-transparent structure shines. With a more lenient disclosure mandate, it provides these firms a comfortable entry point.

They can effectively transpose their established mutual fund strategies into an ETF wrapper without feeling as though they’re laying bare their proprietary insights daily. What’s more, this approach ensures parity between mutual fund and ETF investors.

Great examples of this include the Fidelity Blue Chip Growth Fund (FBGC) and the T. Rowe Price Blue Chip Growth ETF (TCHP), which have attracted around $765 million and $375 million in assets respectively. Both ETFs are attractively priced compared to their mutual fund counterparts at 0.59% and 0.57% respectively, while offering the advantages of an ETF.

With both mediums unveiling their holdings quarterly, there’s a sense of equitable treatment, devoid of any perceived favoritism. Over the long term, this can be a strong selling point for otherwise skittish investors and advisors.

There are additional advantages the semi-transparent structure affords relative to mutual funds. One of the most appealing aspects is the provision of unlimited entry and exit points, granting investors greater flexibility in managing their portfolios in real-time.

Moreover, real-time pricing offers a clear lens into current market conditions, enabling more informed decision-making. This immediacy in reflecting the underlying assets’ value ensures that the investor is not left in the dark, bridging the gap between transparency and strategy confidentiality.

Finally, the structural mechanics of these ETFs often lead to superior tax efficiency. This not only helps in potentially deferring capital gains taxes but also amplifies the overall performance, ensuring that investors receive optimal returns on their investments.

It might all depend on the evolving regulatory landscape

As it stands, these funds predominantly focus on U.S. exchange-listed equities, primarily due to regulatory boundaries. Recognizing this, there’s a strong case for regulators to re-evaluate the current restrictions on semi-transparent ETFs, which could drive greater organic engagement and interest from retail investors and advisors alike.

The investment world is no longer just about stocks and bonds. Alternative assets, ranging from real estate to commodities and even cryptocurrencies, are gaining traction. Moreover, hedge fund-like strategies, which traditionally thrive on confidentiality and strategic discretion, are finding their way into the transparent ETF space.

If semi-transparent ETFs can eventually incorporate these alternative strategies and assets, they’d be offering the best of both worlds: the liquidity and accessibility of ETFs and the strategic expertise of active managers, giving successful funds the chance to broaden their offerings to a greater audience without risking their proprietary strategies becoming public knowledge.

“We were all willing to limit the universe of securities initially to prove to the markets and regulators that semi-transparent ETFs work as advertised,” says Stuart Thomas, founding principal at Precidian Investments. ” Now that it has been accomplished, expanding the universe is a logical next step.”

The transparent ETF structure is already embracing alternative strategies reminiscent of hedge funds. If regulations adapt to allow for the use of international equities, leverage, short-selling, fixed-income and derivatives, thereby allowing the semi-transparent structure to delve deeper into such alternative strategies, we could witness an interesting evolution.

“The initial limitations have absolutely precluded large numbers of asset managers from adopting the wrapper,” Thomas says. “When the regulators ultimately give approval to expand the universe, it will dramatically impact the adoption by the industry in a positive way.”

Such a fusion might also attract more institutional investors and advisors, who traditionally lean towards active mutual fund managers (and hedge funds) for their strategic depth and hard-to-replicate strategies but might appreciate the liquidity and transparency balance offered by semi-transparent ETFs.

Most semi-transparent structures provide real time pricing of the actual portfolio and/or additional metrics (including securities or portfolio overlap) every trading day to facilitate the creation of tight and orderly markets. “”That’s far more information than a mutual fund provides, and nobody has ever referred to them as non- or semi-transparent,” Thomas says.

Why the spotlight and herding also matters

I also think the real challenge facing these semi-transparent ETFs might not lie in their design or intent, but rather in their representation and coverage in the media.

Some of their transparent counterparts, like the ARK Innovation ETF (ARKK) and the JPMorgan Equity Premium Income ETF (JEPI), became poster children for the active ETF industry through their substantial media coverage due to strong outperformance during the 2020 bull and 2022 bear markets respectively.

The surge in attention they received was undoubtedly followed by an influx of investment, a scenario familiar to many in the fund management industry.

Once the spotlight shines on a particular fund or strategy, inflows typically increase, further driving its popularity and prompting even more coverage. This creates a cyclical, self-reinforcing feedback loop that can sometimes overshadow other worthy investment strategies and tools that investors don’t herd into.

Therefore, while the semi-transparent ETFs provide valuable solutions, they might simply have yet to receive their fair share of the limelight, causing potential investors to remain unaware of the advantages they offer.

“As to what will create greater awareness, the industry needs to do a better job of advertising the success of these structures (e.g., they perform as advertised),” Thomas says. “In addition, the continued growth of the ecosystem will give managers confidence that all the elements needed to make them successful are in place so they can add an ETF wrapper to their offerings.”

In an age where media attention can increasingly dictate fund inflows, it’s essential to discern between what’s popular and what’s actually beneficial.

The slow burn of semi-transparent ETFs doesn’t spell their end

It’s tempting, in the face of slowed asset accumulation for semi-transparent ETFs and the rapid ascent of their transparent counterparts, to draw a linear conclusion about the future.

But extrapolating short-term trends to determine the long-term fate of an investment vehicle is rarely a wise move, especially in the ever-evolving world of finance. Just as stock market blips don’t necessarily portend a prolonged downturn, the current trajectory of semi-transparent ETFs doesn’t guarantee their long-term stagnation or demise.

Regulation, much like the movement of glaciers, tends to advance slowly. Each incremental change is the result of extensive deliberations, considerations of potential ramifications, and the careful weighing of risks and rewards.

Yet, despite its unhurried nature, there’s an undeniable trend in financial regulation, especially concerning ETFs: a shift towards flexibility and innovation.

“I think we need to acknowledge that we are in the early days of this new ETF structure and that COVID effectively dampened the initial excitement for over two years,” Thomas says. “The original ETF was introduced in 1993, and it took well over a decade for the market to accept ETFs and start gathering real interest and assets. If you look at semi-transparent ETFs, the industry has already gathered around $5 billion in assets, so it’s off to a respectable start.”

In recent years, the boundaries of the traditional ETF structure have been pushed and expanded. We’ve seen the emergence of single-bond ETFs, innovations like buffer ETFs, and now the investment community is abuzz with the potential introduction of spot crypto ETFs.

Each of these developments underscores a broader narrative – the willingness to experiment and refine the ETF vehicle to cater to the evolving needs of investors. There’s no reason why the same dynamic won’t occur with semi-transparent ETFs.

“Up until recently, semi-transparent ETFs were not allowed on the major BD/Wirehouse platforms. That has changed and will open up the potential audience in a dramatic way,” Thomas says.

While patience is indeed a virtue in waiting for regulatory shifts, the trend suggests that the wait for semi-transparent ETF enthusiasts might not be in vain.

The winds of change, albeit slow, are blowing, and they seem to be pointing towards a more inclusive and innovative future for all ETFs, semi-transparent ones included.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.

Published: October 5, 2023
Author: Tony Dong
Article originally posted at

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