Concerns about intellectual property leakage are creating unease among European asset managers running active exchange-traded funds. Daily disclosure of holdings, long seen as a defining feature of the ETF model, can also make proprietary investment strategies easier to copy. Semi-transparent ETFs are emerging as a way to limit that risk, though this structure has yet to win broad support.
Last year, regulators in Luxembourg and Ireland gave the green light for the use of ETFs that are not fully transparent. Fidelity launched the first semi-transparent ETF on the European market last year, and other players are also exploring the option, including Robeco.
Robeco ETF head Nick King told Investment Officer that considerations around transparency become more relevant as ETFs become more concentrated, underlying investments are less liquid, or strategies have higher turnover. In those cases, he said, the risk of intellectual property being copied increases. “That is not in the interest of asset managers, nor of our clients.”
Limited adoption
According to King, a clear and well-designed structure is essential. In his view, this is one of the reasons why adoption of semi-transparent ETFs in the US has so far remained limited. He points to complex models and a lack of consistency between different structures.
“If Robeco were to explore this route, it would be a starting point for us that our capital market partners are offered full transparency, so they can ensure efficient price formation,” said King, emphasizing that Robeco currently has no concrete plans to launch semi-transparent ETFs.
The ETF expert outlined a model in which holdings are publicly disclosed with a delay, similar to reporting practices for mutual funds. “That enables efficient trading on the exchange, while intellectual property is protected through less frequent public disclosure.” Another option is to publish the main positions without revealing the exact weightings.
In the United States, semi-transparent ETFs often use a proxy portfolio: a substitute portfolio that approximates the characteristics of the actual strategy without providing full insight into its composition.
Fidelity’s ETF
Fidelity not only owns the first but also the only European semi-transparent ETF: the US Fundamental Small-Mid Cap UCITS ETF. The asset manager told Investment Officer that it is seeing strong interest in the product from, among others, private banks, wealth managers, and retail investors.
In Europe, Fidelity uses a structure in which liquidity providers have full daily insight into the portfolio. Clients only receive information about any changes at a later stage. This approach differs from the US version of the ETF, which has existed for almost five years. There, due to laws and regulations, liquidity providers do not always have full access to the actual portfolio, which can lead to less efficient trade execution. European regulators do allow brokers and banks to be given full insight into the portfolio.
“In our view, this means the chances of success for semi-transparent ETFs are greater in Europe. For our liquidity providers, it is business as usual,” said Neil Davies, head of ETF product strategy and management at Fidelity in Europe and Asia-Pacific.
For certain strategies, Fidelity sees clear reasons to use a semi-transparent structure, particularly to prevent imitation by competitors. “In parts of the market such as small- and midcaps, that risk is greater than elsewhere,” Davies said. He acknowledged that the risk of intellectual property leakage is still limited, but nevertheless called it a risk Fidelity does not want to take. “This ETF has delivered strong returns in the US for almost five years. In our view, that justifies the protection of intellectual property.”
Concerns ‘exaggerated’
Not everyone in the sector is positive. Arnaud Llinas, former head of ETF, Indexing & Smart Beta at Amundi and now an adviser at ETFBook, estimated that the likelihood of broad adoption in Europe is low. He sees the European ETF landscape characterized by a relatively limited group of market makers.
“I expect them to demand full transparency to keep spreads tight,” Llinas said. “Since liquidity provision is a scarce resource in Europe, providers that want to protect their intellectual property through semi-transparent structures will struggle to secure sufficient support from market makers.”
In addition, there is skepticism in the market about whether fears of “IP leakage” are justified. Many investors lack the scale to effectively replicate active ETFs. Moreover, the transaction costs of replication may be higher than the cost of the ETF itself.
Fidelity itself also expects semi-transparent structures to be suitable for only a limited part of the ETF market. Of the 24 ETFs the asset manager offers in Europe, 23 are fully transparent. “Transparency is an important reason for choosing an ETF wrapper,” Davies said. “Fully transparent ETFs will remain dominant, but a semi-transparent model can enable asset managers to offer strategies in ETF form that would otherwise remain out of reach.”
According to Llinas, semi-transparency fundamentally clashes with the core values of ETFs. “Asset managers that want to protect their intellectual property will find that this jacket fits poorly with the basic idea of an ETF.”
He pointed to the United States, where semi-transparent ETFs have existed for longer but have gained little traction. “Firms such as ARK Invest show that it can be done differently. They manage concentrated portfolios and report openly on their positions. Transparency has actually become an important marketing tool and differentiating factor there.”