‘An emphatic yes’: Why T. Rowe Price, DFA will offer ETFs for the first time

Two established mutual fund managers are entering the competitive ETF market. Their foray into a market largely synonymous with index investing is a sign of how exchange-traded funds are shifting.

Following new SEC regulation, T. Rowe Price and Dimensional Fund Advisors, asset managers with more than $1 trillion of assets in their U.S. open-ended mutual funds, collectively, are preparing to launch ETFs for the first time.

“I think it's the next big chapter,” says Tim Coyne, who T. Rowe Price hired from State Street at the end of 2019 to lead its forthcoming ETF business. He added: “Ultimately, we are looking to build a comprehensive product suite across asset classes.”

Index funds have dominated the ETF market since their inception. Some 96% of ETF assets — or $4.2 trillion of the $4.4 trillion market — are in index funds, according to Investment Institute Company research from March.

Now new SEC regulation has encouraged asset managers to apply their active strategies to the exchange-traded model known for its tax efficiencies.

In September, the SEC passed an ETF modernization rule, which streamlined guidance around issuance and eased the compliance burden around actively managed ETFs. Later in 2019 it approved the first non-transparent structure, which meant asset managers were no longer required to disclose holdings daily.

Revealing ETF holdings can allow third parties to trade ahead of the asset managers, driving up transaction costs, says Coyne, “which ultimately is not a good result for the strategies or for our end investors.”

T. Rowe, which received preliminary approval for four active ETFs, saw an opportunity which would allow them to “maintain the integrity” of their active strategies and protect their intellectual property, according to Coyne.

While the non-transparent or semi-transparent model has attracted asset managers including T. Rowe Price and Fidelity, other fund companies are issuing active ETFs that disclose all holdings.

BNY Mellon launched its first ETFs earlier this year, some of which were no-fee funds. Dimensional’s first three ETFs, which offer all-cap core equity exposure, will be fully transparent, too.

The passing of the ETF rule “streamlines the whole process,” says Gerard O’Reilly, co-CEO and CIO of Dimensional, noting that no special applications will be required to launch an ETF and that the regulator provided more clarity around custom baskets.

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When the rule was passed by the SEC, “we said an emphatic yes,” O’Reilly says. The number of advisors asking whether Dimensional would offer ETFs had been rising over the past two years, he says.

Interest in active ETFs is no recent phenomenon. DFA has been sub-advising ETFs for John Hancock for five years, according to O’Reilly. T. Rowe has had its eyes on the ETF market for over seven years — it first filed an application for actively managed ETFs with the SEC in 2013.

But now the asset manager has the regulatory go-ahead to dig its heels into the space. T. Rowe’s ETF group has six team members, and it’s growing, according to Coyne. The firm is building out its ecosystem with external partners, including market makers, “all the large banks that have dedicated ETF trading desks,” authorized participants and the exchanges.