BlackRock Inc. has spent three years crafting a new type of actively-managed exchange-traded fund that’s stoked optimism in the U.S. for expansion of the $1.8 trillion industry.
The world’s biggest money manager is confident the product will work, except the market will be a dud.
“We are long the option, but we think it’s deep out of the money,” Mark Wiedman, global head of BlackRock’s iShares ETF unit, said in an interview yesterday at Bloomberg News’ New York headquarters. “We have a process we think would work, but we don’t actually think it will be much of a commercial opportunity.”
BlackRock in 2011 was one of the first U.S. fund managers to ask the Securities and Exchange Commission to approve a non-transparent actively-managed ETF. That product would allow stock-picking fund managers to offer their strategies in an ETF, the fastest-growing investment vehicle over the past two decades. Bats Global Markets Inc. sought approval in a May 16 filing to list 13 such funds planned by BlackRock.
BlackRock’s leading role in seeking approval for a non-transparent active ETF has spurred excitement within asset management for the product’s prospects, according to Todd Rosenbluth, director of mutual-fund and ETF research at S&P Capital IQ in New York.
“It’s a big deal because of BlackRock’s presence with more than 40 percent of the ETF market,” Rosenbluth said today in a telephone interview. “With its brand and with its deep resources, BlackRock could help it get it greater traction if they go this route.”
The proposed vehicle combines the security-picking flexibility of a fund manager with the intraday trading and some of the cost-saving characteristics of traditional ETFs. Companies have been discouraged from introducing actively managed versions of equity funds by the SEC’s requirement for daily disclosure of fund holdings, which would make it easy for competitors to copy, and traders to anticipate, a manager’s portfolio changes.
Transparency is less of an issue on the fixed-income side, where the opacity and negotiated nature of transactions in the over-the-counter bond market protect managers.
ETF providers must disclose holdings every day to enable market makers to execute trades that keep the share price in line with the underlying value of the fund’s assets.
To solve this, firms including BlackRock, Guggenheim Partners LLC, and Precidian Investments have proposed structures that would allow the funds to remain priced in line with assets without revealing those specific positions.
A number of the firms have reported progress in their applications after receiving and answering multiple rounds of questions from the SEC’s staff.
Reggie Browne, head of ETF trading at Cantor Fitzgerald LP in New York, has predicted SEC approval could eventually transform the field of ETF players by clearing the way for traditional mutual fund companies to join the industry.
Wiedman is less optimistic.
“This is a solution in search of a problem,” Wiedman said. “What these truly are, if they ever take off, has nothing to do with portfolio management and costs.” This would disrupt the distribution of active mutual funds, he said.
Active funds, even packaged as ETFs, lack the draw that index-based products have with their low cost, he said. Without that, they will still need distributors incentivized to sell them. “Active products are sold and not bought. Someone has to go out and sell these products to people.”
Rosenbluth said he understands why BlackRock continues to pursue the idea despite Wiedman’s skepticism.
“When you’re that big and that successful, it pays to have a lot of things in the works,” he said. “I’m not surprised they want to keep their options open.”
ETFs are bundles of securities that trade on an exchange, like stocks. Investors in most mutual funds can buy or sell shares once a day, typically after markets close, and only directly with the fund.