The Securities and Exchange Commission said it would grant Vanguard’s request to list active exchange-traded funds (ETFs), according to a September 8 filing. The move could pave the way for other active managers to launch active ETF versions of their mutual funds, putting even more price pressure on producers across the asset management industry.
ETFs have long been recognized as low-cost, tax-efficient structures for index investors, on a growth trajectory far outpacing traditional mutual funds. Yet active managers have been hesitant to adopt ETFs as they require daily disclosure of holdings—akin to giving away the secret recipe of their strategies to the broader market.
“The challenge active managers face is that they don’t want to provide sole transparency of their strategies, but at the same time they’re seeing ETFs gain market share over particularly U.S. actively managed mutual funds,” said Todd Rosenbluth, director of ETF and mutual fund research at CFRA. “It’s easier for them to not participate now because the pool of assets in active ETFs is small and you can say, ‘Well there isn’t yet client demand.’ If Vanguard proves there’s client demand—and we think they will—it’s an easier decision to make.”
There are roughly 190 actively managed ETFs with a total of $40 billion in net assets, according to AdvisorShares. But that is small compared with the total U.S. ETF universe, with $3 trillion in assets, according to ETFGI data.
“I think these [Vanguard] ETFs will be successful in gathering assets,” Rosenbluth said. “And I think it’s going to cause investors and advisors to look more at some of these products that have previously come to market, whether it’s Davis or Legg Mason or other providers."
While there is a "laundry list" of asset managers lining up to produce "nontransparent" actively managed ETFs, Vanguard's foray into active ETFs will "step up the bar for everybody," says Tom Lydon, president of Global Trends Investments and editor of ETFtrends.com. Davis Advisors launched a handful of actively managed ETFs earlier this year, "and were quite bold to do so," says Lydon. He suspects Vanguard's first actively managed ETF may replicate the strategy in their actively managed Wellington Fund, but doesn't think there is a concern that Vanguard will be cannibalizing itself. “This is for ETF fans looking for active managers,” Lydon said.
While daily transparency may be the barrier keeping many active managers out of the space, Ben Johnson, Morningstar director of global ETF and passive-strategies research, believes those fears are overblown.
“I think many are probably flattering themselves and thinking that people are anxious to get their hands on that recipe, but in this case just given the nature of the strategy, [daily portfolio disclosure] is not a very big concern.”
This is not Vanguard’s first foray into active ETFs—with a caveat. Within the last two years, Vanguard rolled out in the U.K and Canada the Vanguard Global Minimum Volatility ETF, Vanguard Global Value Factor ETF, Vanguard Global Momentum Factor ETF and Vanguard Global Liquidity Factor ETF in the U.K. and Canada. Johnson expects the U.S. funds will mimic those already introduced.
“While definitionally, yes, they will be actively managed funds, what we see in those funds listed outside the U.S. is that they’re just ever-so-barely ‘active,’” Johnson said. “They follow a very systematic approach to security selection and portfolio construction that looks an awful lot like an index-based strategy, but the active element is the fact that they retain a degree of discretion over how to trade the portfolio, how to modify the process, and the strategy at any point in the market cycle if they discover that there are certain refinements that might improve the overall performance profile.”
That is fundamentally different from, say, how Davis ETFs manages their funds.
“[Davis managers] are kicking tires, they’re peaking under the hood, they’re meeting with management,” he added. “That in all likelihood will not be the case for this first volley of actively managed ETFs from Vanguard.”
Johnson expects the Vanguard funds to be competitively priced right out of the gate, and he expects that to come down as assets grow.