Big Potential, Big Questions
Prior to 2020, daily portfolio transparency had been the keystone that allowed for the innovative ETF structure. Transparency allowed market participants to accurately price ETF shares2 in real time throughout the day, which was crucial for bringing open-end funds out onto the exchanges. However, it was also the transparency requirement that kept most active managers (particularly active equity managers) from embracing the ETF structure. This dynamic, paired with the popularity and numerous benefits of ETFs, led many around the industry to consider the creation of a non- or semi-transparent ETF to be the “holy grail.”
After years of working towards that grail, the US Securities and Exchange Commission granted approval to several different semi-transparent ETF models in 2019, and the first of these products began trading in the spring and summer of 2020.
With this being the next big step in the evolution of ETFs, everyone in the marketplace – from issuers to liquidity providers to investors – was curious to see how the various products would perform. Would they allow for efficient secondary markets, with tight bid/ask spreads and small premiums and discounts?3 Might some products, and the approaches to semi-transparency that they use, work better than others? Or will they prove too costly or inefficient to be viable?
To answer these questions, we’ll examine two important metrics of secondary market conditions for investors: bid/ask spreads and premiums/discounts. In a nutshell, smaller bid/ask spreads equate to lower trading costs for investors, and small premiums/discounts mean that trades are happening at fair prices. These metrics also make for good criteria to judge these new ETFs on because they speak directly to market participants’ ability to accurately value the ETF shares4 despite the lack of transparency.
Comparing the 15 US-domiciled, semi-transparent ETFs with the longest track record to all other US ETFs, we find that the semi-transparent products are trading with 30-day average bid/ask spreads roughly in line with the overall market. Likewise, the semi-transparent products have average premiums/discounts that are in line with the overall market.
30-Day Average Bid/Ask Spreads
Source: Bloomberg as of 6/21/2021
However, comparing active semi-transparent ETFs to the entire universe of US ETFs may not be the most useful comparison for judging these products. Considering that all of the ETFs in our semi-transparent set are active equity strategies with regional limitations, limiting our comparison to just transparent active equity ETFs with similar geographic exposure might be more appropriate.
Judged this way, the semi-transparent set again has comparable premiums/discounts to the wider universe. However, semi-transparents as a group have actually been trading with tighter spreads than similar transparent products, as illustrated in the chart below.
30-Day Average Bid/Ask Spreads
Source: Bloomberg as of 6/21/2021
Encouraging, Not Surprising
The track record that semi-transparent ETFs have established as a group – across issuers and models – is extremely encouraging, and should give the marketplace confidence that these products can in fact trade efficiently without daily portfolio transparency.
This should not come as a surprise. All semi-transparent ETFs either publish intraday portfolio values, publicly available proxy portfolios,5 or both – serving as tools for the market to effectively price the ETF shares. These are tools that the market has vast experience with, and it’s showing.
Douglas Yones, Head of Exchange Traded Products at the New York Stock Exchange, notes: “With 28 products launched and over $1 billion in Assets under Management (AUM) in its first calendar year, the active semi-transparent ETF market is providing new growth opportunities for issues and investors alike. The NYSE has been working closely with all ETF market participants, from regulators to market makers, to provide a deep and liquid trading environment, and we’re encouraged by the strong adoption across the ecosystem.”
One year after the first semi-transparent ETF was launched in the US, these innovative products have passed a major test by showing that they can trade effectively in the secondary markets. Investors have begun to take notice, too. Over $1 billion has been allocated to semi-transparent ETFs during their first year. This track record of success should lead to continued increases in investor confidence in these products, and many more issuers jumping in with actively managed ETFs.
2 An exchange-traded fund’s (ETF’s) market price is the price at which shares in the fund can be bought or sold on the exchanges during trading hours.
3 Here, the terms “premium” and “discount” refer to whether or not an exchange-traded fund (ETF) is trading at more or less than its net asset value (NAV) or intraday net asset value (iNAV). ETFs trading at a price that is higher (or more than) NAV or iNAV are said to be trading at a premium, whereas ETFs trading at a price lower (or less than) NAV or iNAV are said to be trading at a discount.
4 An exchange-traded fund’s (ETF’s) net asset value, or NAV, represents the value of each share’s portion of the fund’s underlying assets and cash at the end of each trading day.
5 A proxy portfolio is a broad representation of the overall market, used to simplify studies that require a market variable, statistic, or comparison.
Exchange-Traded Funds (ETFs) trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are not individually redeemable directly with the Fund, and are bought and sold on the secondary market at market price, which may be higher or lower than the ETF's net asset value (NAV). Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
All investing involves risk, including the risk of loss. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.