The actively managed exchange traded fund space has become more lively with the addition of non-transparent ETFs, but with the year coming to an end, some of these new non-transparent offerings face year-end capital gains distributions.
Analysts and executives warned that a lack of redemptions from non-transparent products, along with their limited ability to use custom baskets in tax management, have caused several non-transparent ETFs to pass along year-end capital gains distributions, the Financial Times reports.
Among the 19 active non-transparent ETFs trading on January 1, 2021, 10 will issue a year-end capital gains distribution. Of the 10 non-transparent ETFs distributing capital gains, two will come with more than 5% of the ETF’s net asset value. The Fidelity Blue Chip Value ETF (FBCV) is even expected to distribute a larger gain than its mutual fund counterpart.
In comparison, just 2% of the equity ETFs offered by the biggest ETF fund sponsors, including BlackRock, Vanguard, and State Street Global Advisors, issued a capital gains distribution for the year, according to CFRA data.
Many money managers have jumped into the non-transparent ETF space with clones or close mimics of existing mutual funds in the hopes of attracting more investor interest for actively managed strategies in a cheaper and potentially more tax-efficient investment vehicle. Many have strayed away from the traditional ETF wrapper into the non-transparent space in a bid to shield their secret sauce or better hide their proprietary trading strategies from potential front runners.
However, non-transparent ETFs have not been able to fully capitalize on the efficiencies of traditional ETFs through the use of the in-kind creation and redemption structure, or swapping a portfolio of securities with high embedded gains through so-called in-kind redemptions and using custom baskets to make portfolio moves without triggering a taxable event.
Furthermore, active strategies tend to have higher turnover rates compared to indexes due each individual manager's style, which then increases the chances of a taxable event. Consequently, many active non-transparent strategies have not been able to fully wash out the tax consequences of their trade executions.
Some, though, argue that this is not a big deal.
“We’ve been trying to deliver the message: ‘It’s not like these won’t pay any capital gains, but it’s all about maximising after-tax returns,’” Ed Rosenberg, head of American Century’s ETF business, told the Financial Times, adding that the non-transparent ETFs aimed to distribute gains that were 50% less than their equivalent mutual funds.
Similarly, Fidelity was “pleased with what we’ve seen so far” regarding its active equity ETFs being more tax-efficient than mutual funds, according to Greg Friedman, head of ETF management and strategy at Fidelity Investments.
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