American Century puts nontransparent ETFs on the map

American Century Investments made an announcement on Thursday, officially making it the first asset manager to launch actively managed nontransparent exchange-traded funds.

The $148 billion asset manager was widely expected to be the first on the block with the unique fund structure, which trades throughout the day like other ETFs but only discloses its underlying holdings through quarterly public filings.

Ed Rosenberg, head of ETFs at American Century, said the COVID-19 pandemic had delayed the launch of the two new ETFs only slightly as a result of logistical issues related to gathering signatures from various market participants involved in trading and market-making.

“Everyone within the system has to be comfortable launching this structure within the market, and talking with everyone, they had no reservations with us going out the door,” Rosenberg said.

During the first 15 minutes of trading Thursday, American Century Focused Dynamic Growth (FDG) and American Century Focused Large Cap Value (FLV), each traded 101 shares.

The stock market volatility in response to the fast-spreading coronavirus has the S&P 500 Index down nearly 24% from the start of the year. That kind of volatility is generally seen as an opportunity for active managers to navigate around trouble spots.

“In times of volatility, active management can really shine, because active management is more about owning the right securities,” Rosenberg said. “Who knows how long this will last. We could be in this stage a month or the entire year, but we think it’s good to give investors a choice.”

As an example of how active management can navigate these choppy markets, the American Century Focused Dynamic Growth mutual fund (ACFOX), which employs a strategy similar to the Dynamic nontransparent ETF, is down just 10.5% from the start of the year, or less than half the decline of the S&P.

The general concept of a nontransparent active ETF is to put an ETF wrapper around an actively managed strategy without disclosing the underlying holdings on a daily basis, as all other ETFs do. But each nontransparent ETF structure that has passed SEC scrutiny so far is unique in the way it provides enough portfolio transparency and guidance to keep market-makers engaged for the sake of liquidity.

In most cases, the underlying holdings will be disclosed quarterly, which is the way active mutual funds report their holdings. In that sense, these products are part active mutual fund and part ETF.

“The launch of these active equity ETFs has been long awaited by the ETF industry and it gives American Century the chance to showcase its management skills in tax-efficient products that investors have been gravitating to,” said Todd Rosenbluth, director of mutual fund and ETF research at CFRA.

“We think those investors that favor stock selection will not have much concern about the limited holdings transparency and will consider them if they have a favorable view on American Century,” Mr. Rosenbluth said. “Yet those that want low-cost index-based products will ignore these as they do many other new launches.”

On the cost front, the Dynamic Growth ETF charges 45 basis points, and the Large Cap Value ETF charges 42 basis points.

Acknowledging the importance of maintaining the kind of tax efficiency that ETF investors have come to expect, American Century has named Rene Casis, the head of the ETF portfolio management team, as part of the portfolio management team for each of the new funds.

The Dynamic Growth ETF is also led by Keith Lee and Michael Li. The Large Cap Value ETF portfolio leadership includes Kevin Toney and Phil Davidson.

The asset management industry has been talking up nontransparent ETFs as the best of both worlds because they will offer access to tested active portfolio management at lower fees and without the tax inefficiencies that plague mutual funds.

Through mid-March, at least two dozen asset managers had signed licensing agreements with firms approved to offer nontransparent ETFs. But financial advisers, the largest consumers of ETFs, are barely paying attention so far.

A 2019 survey of more than 150 financial advisers by Cerulli Associates found that less than 16% plan to allocate client assets to nontransparent ETFs during the first year they’re on the market, while 31% said they would not use them. More than 35% of respondents said it would depend on the details and structure of the products.

Time will tell if advisers are ready to reconsider and start taking a fresh look at the asset management industry’s latest wrapper.