On December 10, the SEC approved new proxy-based, semi-transparent active ETF structures from Natixis/New York Stock Exchange (NYSE), T.Rowe Price, Fidelity, and Blue Tractor Group. While each of the products is unique, they all use “proxy baskets” to avoid the possibility that investors will use disclosed information about an ETF’s holdings to front run the strategy. These structures may provide a compelling option for active managers to enter the ETF market without revealing their “secret sauce.” In this edition of Exchange Thoughts, we break down the different features of these active structures.
Transparency in ETFs
Generally, managers are required to disclose the holdings of their ETF, both the underlying securities it contains and their relative weightings in the fund, every morning prior to market open. For active managers, the concern around this level of transparency is that it may give away the proprietary strategy that the manager has developed, at the expense of the fund and shareholders.
While the approval of Precidian’s ActiveSharesTM model in May opened the door to non-transparent active ETFs, there is a distinction between this new wave of ETF structures and the Precidian model. These new ETF structures introduce the concept of a representative proxy basket, which enable managers to camouflage or shield the underlying securities held in the ETF. These proxy baskets are designed to offer enough detail so authorized participants (APs) and market makers can efficiently trade the portfolio and hedge their exposure without disclosing the true fund holdings. Additionally, the proxy portfolios will be used by APs to support the creation and redemption of ETF shares. Asset managers considering these newly approved structures, should be aware of the differences in how the proxy basket is derived and the added data that needs to be disclosed to investors. Like Precidian’s ActiveShares, these four structures are limited to securities that trade contemporaneously with the US market.
Precidian’s ActiveShares Non-Transparent ETF Model
ActiveShares ETF structure allows managers to shield their investment strategy to investors and the public. Rather than delivering the funds’ basket to the street each day, ActiveShares ETFs will only send the basket to a new entity called an authorized participant representative (APR). APRs are the only entities outside of the fund’s manager, custodian, and verified intraday indicative value (VIIV) agent to see the ETF’s underlying positions each day. The APR will use a confidential account to facilitate creation and redemption orders placed by the funds’ APs. The APR will also manage in-kind delivery of the basket constituents and ETF shares. ActiveShares, like all of these new “active” product structures, is expected to offer investors the same key benefits as traditional ETFs, such as tax and cost efficiency.
