The ETF industry is celebrating its latest impressive innovation: The non-transparent active ETF structure. The concept is so novel and has so many applications that the providers lined up to offer this product have not yet standardized the name for them. They have been referred to as non-transparent or semi-transparent, actively managed ETFs; active shares; and even ANTS (Active Non-Transparent ETFs). Whatever you call them, celebration is well-deserved because of the five plus year regulatory slog that it took to obtain SEC approval of this product.
Certainly, there is a strong possibility that the roll out of the non-transparent active ETF structure will be the next major milestone in the ETF industry. But what may be even more significant is the absence of the 28 year old ETF industry chatter about the next great product innovation. Has the ETF product run its course in terms of innovation similar to the mutual fund, closed-end fund and unit investment trust?
The lack of next blockbuster ETF product should not be viewed as a negative, but rather a reality. In fact, it is likely healthier for the industry to pivot from trying to develop the next newfangled ETF product to pouring its energy and resources into figuring out how existing ETF products can better be distributed to and used by investors. Much like many maturing industries, innovation naturally will shift from production to distribution. For ETFs, innovation on the distribution front is long overdue as the ETF industry has struggled to replicate the historic mutual fund distribution model that still successfully relies upon charging the investor a purchase price (i.e., a load) for mutual fund shares and dipping into the mutual fund’s actual assets (via a Rule 12b-1 fee) to incentivized financial intermediaries to sell fund shares. Because ETF shares trade on exchanges, this model is not available to ETF providers and they are left with reaching into their own pocket to use legitimate profits from the advisory fee to compensate intermediaries who sell shares of their ETF shares. Furthermore, it is often difficult for the ETF provider to know who to pay. On the one hand, mutual fund shareholder accounts are often held directly at the fund’s transfer agent and since these shareholders are easily identifiable, they become customers who receive direct marketing from the fund provider. ETF providers on the other hand remain in the dark about who their shareholders are, making it difficult for such shareholders to morph into their customers.
As products based on the non-transparent active ETF structure gain regulatory approval and begin to launch, the ETF industry must innovate ways to distribute these and traditional ETF products. Such innovation is especially critical for small- and mid-sized ETF sponsors that swim in the same ecosystem as three goliath ETF providers that have garnered over 80% of ETF assets under management. If a firm is not one of these goliaths, it must further contend with the fact that the best avenue for distribution leads to a handful of brokerage firms control the largest ETF distribution platforms, all with close ties to the goliaths.
ETF BILD’s outlook for 2020 showcases the opportunity to identify the ETF distribution challenges and stimulating ideas, and thoughtful approaches to how best the lineup of ETF products can be distributed, especially by the small- and mid-sized ETF providers. New technologies, interface demands from Gen Xs, Ys and Zs and other trends may be indicators to what types of distribution innovations are necessary to ensure that ETFs, in whatever shape and form, continue to thrive.
As ETF BILD remains devoted to providing education to the industry, its founders will continue to seek out the knowledge and experience of thought leaders, providing an engaging platform to share their views and ideas. Comments are welcomed below, should you be interested in sharing your thoughts on this topic.