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Actively-Managed ETFs

Frank Koudelka, our global ETF product specialist, and Jeff Sardinha, head of ETF bridge team, spoke with Tim Coyne, global head of ETFs, and Scott Livingston, global head of ETF strategy and capital markets at T. Rowe Price, about their entry into the ETF market, their growth strategy, and their challenges and future plans.

December 2022

Exchange-traded funds (ETFs) have been historically synonymous with indexing or passive investing. The first true actively-managed ETF was launched in 2008. ¹ For the first 10 years that the actively-managed ETFs were available, they never exceeded US $10 billion in net annual inflows, and the market share remained at one percent of the overall ETF market. A shift began to occur in 2015 when the regulatory environment began to ease some of the barriers to growth. These included: the lifting of the derivatives moratorium, allowance of international ordinary equities, expansion of generic listing standards, approval of periodic holdings disclosure, passage of the ETF Rule and enabling the conversion of mutual funds to ETFs. Taken in aggregate, the changes have expanded the toolkit for active managers to effectively participate in the ETF marketplace.

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Frank Koudelka
Global ETF Product Specialist

Tim Coyne
Global Head of ETFs

Jeff Sardinha
Head of ETF Bridge Team

Scott Livingston
Global Head of ETF Capital Markets

Frank: State Street first partnered with T. Rowe Prices’ ETF efforts in 2011, 10 years before your launch. We worked on developing workflows and contemplating technology changes to support the proposed model. Scott, you were there pretty much from the start. Can you take us down the memory lane and discuss what changed and what stayed the same?

Scott: Thanks Frank. And you are correct – it was a long journey but one we thought was incredibly important so that investors had a choice when it came to ETFs and weren’t restricted to only index returns less fees. Our conversations with regulators extended way back – there are even mentions as early as 2009 in the Wall Street Journal about our thoughts on active ETFs.

To address your question – what stayed the same was our goal and our core beliefs. Our goal was to offer investors the ability to access our active management expertise in the ETF wrapper – a wrapper that offers certain investors benefits relative to other product structures. Where this became tricky, particularly on the active equity side, was that the Securities and Exchange Commission (SEC) had always required ETF issuers to disclose holdings each day as a condition for approval. Underpinning the SEC’s requirement of daily holdings disclosure was their belief that would enable market makers to price ETFs around their net asset value (NAV) if they had this data resulting in good trade execution for investors. We agreed with the SEC that it was important for ETFs to trade around NAV, but we believed that there was other information that market makers could use to ensure orderly and efficient ETF trading markets.

For passive products, disclosing holdings each day was not an issue and the information had very little value since in most cases the benchmark constituents and weights were already widely known. As an active manager, we were concerned that disclosing our holdings each day could lead to the front-running of our trading strategies, which ultimately increases our transaction costs and hurts our client’s performance. So instead, we went to work on developing an efficient ETF process that would shield our investment intellectual property thereby protecting our client’s performance, while also giving market makers the information they needed to make markets in our ETFs. We wanted to accomplish both objectives without complicating the ETF structure in the marketplace. To do this, we engaged with the entire ETF ecosystem – State Street included – to collectively develop a model that would make sense so that we could garner broad support for our proposal.

While some of the languages of our process and supporting data points may have changed during our conversations with the SEC, perhaps the biggest change during this period was investor preferences. We saw ETFs continue to grow in an explosive way as more taxable investors began to appreciate the convenience, versatility, relative tax-efficiency and lower costs of the ETF wrapper. This only added further conviction to our belief that it was important to get a model approved that would allow active managers the ability to offer ETFs without subjecting investors to performance degradation. The SEC, to its credit, also noticed more investors gravitating to ETFs and put in the work to understand the various proposals to ensure they would operate as intended in the market. While the journey may have taken some time, we believe the outcome is a big win for investors of all kinds. For those that prefer active management, they can now consider the ETF wrapper. For investors that prefer the ETF vehicle, they now have added choice if they want to go beyond the returns of a benchmark.

Frank: Thanks Scott. So, although it was a journey of more than 10 years with the regulators, all of the T. Rowe Price-stated goals remained in place when approval was finally granted. Turning to you Tim. You joined T. Rowe Price later in the ETF journey with a strong pedigree of the investment wrapper, including stints at the American Stock Exchange and running the global capital markets function for the SPDR ETF business. What are you most excited about?

Jeff: A key tenet of the T. Rowe Price launch was to protect trading strategies, which protects investors, but also not to complicate the ETF structure for the marketplace. Scott, how has this been accomplished?

Jeff: Tim, so we’ve heard about the thoughtful journey that T. Rowe Price undertook to enter the ETF market. What results have you seen thus far?

Frank: Scott, there has been a broader debate in the market and that’s active versus passive. This led to much of the growth of ETFs at the expense of mutual funds. But at the same time, actively-managed ETFs are becoming a larger and larger segment of the ETF market. How does T. Rowe Price think about this as it relates to its launch?

Frank: Tim, T. Rowe Price has now expanded from its initial launch of five equity ETFs to three fixed income ETF launches. Tell us about that and future plans both domestically and globally.

Jeff: Has T. Rowe Price contemplated converting any of its mutual funds to ETFs? Why or why not?

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