On May 20, the SEC gave Precidian Investments approval to license its ActiveSharesSM actively-managed, non-transparent ETF structures – the first ETF of its kind to gain initial approval by the SEC. The approved filing limits ActiveShares ETFs to holdings listed on US exchanges that trade during the same hours as the ETF. The approval may open doors to new product types.
Currently, ActiveShares has license agreements with nine fund managers, including Legg Mason, BlackRock, Capital Group, JP Morgan, Nationwide, Gabelli, Columbia, American Century, and Nuveen. The ActiveShares approval represents a major milestone as it is the first pure ETF product where managers are packaging active strategies in a non-transparent manner.1 Active managers who have hesitated to venture into ETFs may now make their strategies available to a wider audience of investors without revealing their “secret sauce.” Until now, active managers have been entering the ETF market through smart-beta indexed funds or actively managed transparent ETFs.
In this edition of Exchange Thoughts, we discuss the potential features of this new structure and highlight key considerations for managers contemplating this model.
What is ActiveShares
ActiveShares is a new type of ETF structure that allow its managers to shield their investment strategy to investors and the public. While most ETFs today require daily portfolio disclosure, which exposes active managers’ trading strategy, the ActiveShares funds will disclose daily holdings only to an “authorized participant representative,” a new role within the ETF ecosystem. Authorized participant representatives are the only entities outside of the fund’s manager and the custodian to see the funds underlying positions and will use a confidential account to acquire and dispose of the underlying basket securities on behalf of the authorized participant (AP). Lastly, the industry expects ActiveShares will have the same key benefits as traditional ETFs, such as tax and cost efficiency, and broker-dealers could add these products to intermediary platforms as they do with ETFs today.
ActiveShares seek to replicate the cost savings of ETFs while not disclosing the proprietary investment strategy and process of the manager. For some managers, this may present a compelling opportunity. Those interested in the product should also consider the following:
- It’s an ETF. Because it is an ETF, ActiveShares requires no new technical changes and fits seamlessly into existing platforms. This makes it easy for licensees to provide active investment strategies in an ETF structure.
- There is a new role. Previously, only APs controlled how trades were executed. Now, authorized participant representatives, who are independent of the AP and the fund, will use confidential accounts to buy and sell basket shares on behalf of the APs.
- Intraday valuation goes a step further. ActiveShares functions similarly to existing ETFs by requiring a verified intra-day indicative value (VIIV) based on the portfolio holdings, which provides a consistent intraday price to the market. While all other ETFs publish an intraday indicative value every 15 seconds, ActiveShares will take it a step further and publish the VIIV every second.
- AP hedging and arbitrage still exists. By using the VIIV and disclosed holdings, and engaging with the ETF manager to understand the investment strategy, APs should have enough information to identify arbitrage opportunities to effectively hedge their positions.
- Creation unit size is smaller than a traditional ETF. Creation units will be 5,000 shares or more. Licensees anticipate that the price of a share will range from $20 to $60, and that the price of a creation unit will range from $100,000 to $300,000.
Questions for Managers
ActiveShares is patent-protected, so managers considering this structure will be required to enter into a licensing agreement with Precidian directly. This product may appeal to an asset manager who is managing active strategies and is wary of publishing their holdings daily. In addition to the licensing agreements, managers should ask themselves:
- How will I price an ActiveShares product alongside my existing investment menu?
- Should I seek to replicate existing strategies or launch something new?
- What are the operational nuances that are unique to ActiveShares products?
- What additional costs may be inherent in this structure?
- How will my interaction with my APs change to ensure they can hedge their exposure?
- What will my oversight of the authorized participant representative entail and how many do my products need?
- How will my capital markets team support ActiveShares?
Structural Innovation is Gathering Momentum
In addition to Precidian, another half dozen applications are with the SEC to offer products under a non-transparent or semi-transparent actively managed ETF structure. Should the SEC grant full approval in May, we expect more active ETF products will come to market shortly thereafter. According to the BBH 2019 Global ETF Investor Survey, many investors would like to see more active ETFs in the market (“Active ETFs” ranked first in the US and Europe). This suggests the debate between active and passive isn’t necessarily a binary choice – ETF investors may still find active management attractive; they just want it in a lower cost wrapper.
We expect 2019 to be another busy year in the ETF market with further innovation in both product structure and investment strategies. We believe the space will continue to see large, established asset gatherers enter the market, given the proliferation of smart-beta strategies as well as the ongoing development of new and innovative structures that allow them to port successful strategies into new product wrappers. Although the Precidian structure is currently only licensed in the US, as the global ETF market continues to mature, we expect that the structure could be the blueprint for non-transparent ETFs in Europe and Asia.
Asset managers should consider what strategies may work in this wrapper and how an ActiveShares offering could be added to their capabilities. BBH is ready to discuss these products in more detail and welcome the opportunity to engage with firms in deeper dialogue about this development.
Over the past 15 years, Brown Brothers Harriman (BBH) has partnered with more than 40 asset managers and sponsors to bring ETFs to market in the US, Europe, and Hong Kong. BBH has worked with Precidian, managers with license agreements, and other third-party providers to design an operating model to service and launch these products.
1 In February 2016, NextShares gained SEC approval to license a semi-transparent exchange traded managed fund model.
Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. Pursuant to information regarding the provision of applicable services or products by BBH, please note the following: Brown Brothers Harriman Fund Administration Services (Ireland) Limited and Brown Brothers Harriman Trustee Services (Ireland) Limited are regulated by the Central Bank of Ireland Brown Brothers Harriman Investor Services Limited is authorised and regulated by the Financial Conduct Authority Brown Brothers Harriman (Luxembourg) S.C.A is regulated by the Commission de Surveillance du Secteur Financier. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2019. All rights reserved. IS-04977-2019-04-10