What are semitransparent ETFs?
First launched in 2020, the number of semitransparent ETFs continues to grow. Find out what makes these ETFs different from fully transparent ETFs and why they might make sense for certain active investment strategies.
Transparency is one of the often-touted benefits of ETFs, along with liquidity and tax efficiency, seen as a benefit to investors who have access to a fund’s daily holdings if desired. In 2019, the SEC gave regulatory approval to the first semitransparent ETFs, a development that gave active ETF managers the ability to keep their strategies somewhat hidden.
Active ETF marketplace flourishes
In the years since, active ETFs have become quite popular with issuers and investors alike. However, many popular active ETFs follow a fully transparent model while their semitransparent peers have yet to garner as much interest. As of the end of September, $7.1 billion was invested in semitransparent active equity ETFs, a fraction of the total ETF market. However, this number marks a significant increase for the category and, importantly, these funds have seen continued flows since they first hit the market in 2020.
As ETFs continue to take market share, investors and financial professionals are clearly embracing the lower costs, tax efficiency, and intraday liquidity of ETFs. Active ETFs have gathered an increasing percentage of ETF inflows, most of them using the original, fully transparent ETF structure.
Some investors like the daily portfolio disclosure of ETFs, so they know exactly what they’re buying. The growth of semitransparent ETFs means more investor education is required on this key feature. And since there are several semitransparent ETF formats, it’s important to understand the differences and nuances.
It’s also important to keep in mind that the original, fully transparent ETF structure still works very well for passive, index-tracking strategies, as well as smart beta and some actively managed strategies.
Semitransparent ETFs vs. fully transparent ETFs at a glance
Source: John Hancock Investment Management, as of 10/31/23. AP refers to authorized participant. NAV refers to net asset value.
Why semitransparent ETFs?
There are just north of 50 semitransparent actively managed ETFs so far, but that number could rise in the future.
That’s because semitransparent ETFs may offer solutions to two of the key issues that likely inhibited faster growth of actively managed ETFs. Semitransparency helps protect active ETF shareholders from:
- Risks of front-running (or trading in advance of) the ETF’s trades, which could hurt performance
- Investors replicating the manager’s strategy
The main challenge of designing semitransparent ETFs was striking the right balance between the necessary portfolio transparency so the ETF functions properly, while not giving too much away so that investors don’t suffer from traders attempting to front-run the ETF’s moves. Also, active managers have never been enthusiastic about revealing their trades in real time.
How do semitransparent ETFs work?
We’ve previously explained why the creation and redemption process of ETFs is critical to their functioning and attractive features, including tax efficiency and intraday liquidity. ETFs can be bought and sold during the day, while mutual funds are priced once per day at the market close.
Portfolio transparency is required for the creation and redemption of ETF shares to work smoothly, based on supply and demand for the ETF shares. Transparency also helps keep the price of an ETF share in line with the net asset value (NAV) of the underlying portfolio to help ensure investors are getting a fair price. Most ETFs release an estimated NAV every 15 seconds throughout the trading day and disclose the portfolio holdings daily.
As their name suggests, semitransparent ETFs don’t reveal the entirety of their portfolio in real time–although they do typically disclose large portions of their holdings daily (80% as an example), and their full holdings on a periodic basis, such as quarterly.
AP reps and proxy portfolios
The big change for semitransparent ETFs is that they aren’t required to disclose their full holdings daily. However, they aim to reveal enough so that the ETF can trade properly. The challenge of shielding the remaining holdings has so far been addressed by two main approaches:
- The use of authorized participant (AP) representatives
- Disclosure of proxy portfolios
Let’s cover AP representatives first. APs are brokers, financial institutions, and market makers that facilitate the creation and redemption of ETF shares. Some semitransparent ETFs don’t disclose their holdings publicly, but rather only to what’s called an AP representative, on a daily basis. In other words, only the AP representative knows exactly what’s in the ETF and is under contractual agreement to maintain confidentiality. When ETF shares need to be created or redeemed, the AP representative handles the task of buying (or selling) the entire portfolio holdings in a confidential account and delivers or takes ETF shares from the AP. This extra layer is designed to prevent any potential or even perceived conflicts of interest.
On the other hand, some semitransparent ETFs use proxy portfolios or limited portfolio disclosure. For example, some semitransparent ETFs release their portfolio holdings daily, but not the exact individual weightings of the securities. Other semitransparent ETFs disclose proxy portfolios that are designed to closely resemble the actual portfolio and help market makers and APs manage risk and hedge positions in order to create or redeem ETF shares. These proxy portfolios are typically generated by computers, risk tools, and algorithms.
Putting it all together
There are different ETF structures and each one is designed to achieve its strategy—whether it’s active management, passive investing, or smart beta.
We believe fully transparent ETFs work just fine for passive and smart beta and for some actively managed strategies. Meanwhile, semitransparent ETFs may be a better fit for a certain set of actively managed funds, including those that are offered in both ETF and mutual fund formats since all shareholders will own the same securities. Therefore, we take a somewhat agnostic view on semitransparent or fully transparent ETFs—the “best” structure depends on what the ETF is trying to achieve.
Important disclosures
Investing involves risks, including the loss of principal.
This material is not intended to be, nor shall it be interpreted or construed as, a recommendation or providing advice, impartial or otherwise. John Hancock Investment Management and its representatives and affiliates may receive compensation derived from the sale of and/or from any investment made in its products and services.
Traditional ETFs tell the public what assets they hold each day. Semi-Transparent ETFs will not. This may create additional risks for your investment. For example: You may have to pay more money to trade the ETF’s shares. This ETF will provide less information to traders, who tend to charge more for trades when they have less information. The price you pay to buy ETF shares on an exchange may not match the value of the ETF’s portfolio. The same is true when you sell shares. These price differences may be greater for this ETF compared to other ETFs because it provides less information to traders. These additional risks may be even greater in bad or uncertain market conditions.
The shares are not individually redeemable and owners of the shares may acquire those shares from the ETF and tender those shares for redemption to the ETF in creation units only.
ETF shares are bought and sold through exchange trading at market price (not NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions will reduce returns.
Investors should request a prospectus or summary prospectus from their financial professional. The prospectus includes investment objectives, risks, fees, expenses, and other information that should be considered carefully before investing.
JHS-455014-2023-11-09