Hiding in Plain Sight: Inside the Non-Transparent Active ETF Race

Episode Summary

Executive Summary: The episode covers three major ETF industry developments: Schwab’s move to zero trading commissions, the SEC’s approval of a long-awaited ETF rule that eases fund launches and custom baskets, and the emerging push for non-transparent active ETFs. The discussion argues these changes favor investors and smaller firms, while potentially reshaping how active managers compete with passive strategies through better tax efficiency, access, and pricing.

Main Topics: Schwab’s zero-commission move and the fee war (Priority: 5/5): Schwab cutting commissions on stocks, ETFs, and options accelerates industry pressure toward zero fees. The hosts debate investor benefits, company revenue exposure, and whether revenue lost in commissions may reappear through spreads or order flow economics. SEC ETF rule modernization (Priority: 5/5): The SEC approved a long-delayed rule that streamlines ETF launches by removing the need for exemptive relief and broadens flexibility through custom baskets, especially benefiting fixed income and active ETF structures. Non-transparent active ETFs as a bridge for active managers (Priority: 5/5): Dan McCabe of Presidian explains a structure designed to let active managers use the ETF wrapper without daily holdings disclosure, preserving intellectual property while giving investors real-time pricing and ETF tax advantages. Tax efficiency and structural advantages of ETFs (Priority: 4/5): A major theme is that ETFs can reduce capital gains distributions and other costs versus mutual funds, making them attractive for taxable investors and a compelling migration path for active strategies. Competition between proprietary and proxy-basket ETF structures (Priority: 4/5): The conversation contrasts Presidian’s trusted-agent model with competing proxy-basket designs from firms like T. Rowe Price, Fidelity, Blue Tractor, and Invesco, highlighting that structure and licensing choices may shape adoption. The future of active management and mutual fund conversion (Priority: 4/5): The hosts and guest explore whether converting mutual funds into non-transparent active ETFs could help active managers stop losing assets to passive products and regain competitiveness, especially if platforms and advisors accept the new wrapper.

Key Arguments: Schwab’s fee cut is part of a broader industry race to zero that has already been driven by Vanguard and other firms. Lower commissions help retail investors, but some of the savings may be offset by wider spreads or other trading frictions. The SEC rule could reduce launch costs and operational complexity, but market pressure and low-fee competition may limit the number of new launches. Non-transparent active ETFs address a key barrier for active managers: the need to reveal holdings daily and expose proprietary strategies to copying or front-running. ETFs are valuable not only for transparency but for real-time pricing, exchange access, and tax efficiency. Active ETFs may be especially attractive because they can lower capital gains distributions and remove mutual fund costs like transfer agency and 12b-1 fees. The biggest adoption hurdle is not the structure itself but whether investors and asset managers believe the strategy and economics are compelling enough to move from mutual funds to ETFs. Some mutual funds may eventually convert directly into ETF structures, especially if that preserves scale and improves efficiency. The market’s shift toward passive is real, but the new structure could help active managers compete on a more level playing field rather than forcing them to disclose their “secret sauce.”

Data Points: Schwab commission revenue exposure: 7% - Eric notes Schwab gets about 7% of revenue from commissions, implying less dependence than some peers. TD Ameritrade commission revenue exposure: 36% - Used to explain why TD Ameritrade was hit harder by Schwab’s zero-commission move. E-Trade commission revenue exposure: 17% - Used to illustrate that E-Trade is more exposed to commission cuts than Schwab. ETF industry assets: $7.5 trillion - Joel cites this as the size of the ETF/index fund world during discussion of active vs. passive flows. Active mutual fund assets: $12 trillion - Used to show the much larger legacy active mutual fund market that may convert over time. ETFs paying capital gains: 6% - Eric says only 6% of ETFs paid capital gains, emphasizing tax efficiency. Active ETFs paying capital gains: 20% - Cited to show active ETFs still have more tax friction than the ETF universe overall. Transparent active ETFs share of assets: less than 2% - Eric says roughly 250 transparent active ETFs account for under 2% of assets. Equity active ETF share excluding fixed income: about 0.4% - Used to underscore how weakly non-bond active equity ETFs have resonated. Organic flow concentration: 97% of flows into products at 20 bps or less - Eric says this cost pressure makes launches more conservative and difficult. Growth in active transparent/index ETFs: 400% over four years - Rachel notes growth in active/index-style ETF products despite small absolute size. Number of licenses claimed by Presidian: 14 of the largest active managers - Dan says many major managers have licensed the structure, signaling incoming interest. Issued patents around the structure: 7 or 8 - Dan says Presidian has multiple issued patents around the trusted-agent and indicative value processes.

Pivotal Quotes: "We think that we have the right mousetrap." — Dan McCabe: Used to assert confidence that Presidian’s non-transparent active ETF structure will win against competing models. "ETFs are known for real-time pricing and access." — Dan McCabe: Dan pushes back on the idea that transparency is the core ETF feature, arguing access and pricing matter more. "I think this is just all part of the Vanguard effect." — Eric Balchunas: Eric frames the Schwab commission cuts as the latest step in the broader race to zero initiated by Vanguard.

Implications: If non-transparent active ETFs gain traction, active managers could regain relevance by combining secrecy, tax efficiency, and exchange access. Expect more filings, possible mutual fund conversions, and intensified fee competition across the asset-management industry.