The Jungle of the $2 Trillion ETF Market Gets Denser

  • Eaton Vance's non-transparent ETF began trading Friday
  • Tradeweb now offering private off-exchange ETF trading in U.S.

The $2 trillion market for U.S. exchange-traded funds is growing more opaque even as regulators warn the asset class is already too complicated for some investors.

Eaton Vance Corp. began offering a new type of ETF on Friday -- called Eaton Vance Stock NextShares -- that only reveals its underlying assets monthly, rather than the daily disclosure that’s common in the rest of the industry. Soon, that lag will get longer, as other fund issuers plan ETFs that discuss holdings only every quarter.

Separately, investors can now trade ETFs privately on Tradeweb Markets.

The ETF market has exploded in size, jumping 2 1/2 times in value since the end of 2009. Even before these Eaton Vance and Tradeweb innovations, U.S. officials were already worried the business lacks sufficient transparency. Cracks in the system were revealed on Aug. 24, when many equities didn’t open for trading, yet the ETFs that hold them did, causing confusion among investors about their value.

Kara Stein, a U.S. Securities and Exchange Commissioner, earlier this month expressed concern that the ETF market has already become too difficult for retail investors to understand.

ETF Risks

“I fear that the risk presented by some of these new products may not be fully understood by those who have invested in them,” Stein said at a conference in Washington, speaking generally about new ETFs. “Indeed, even plain-vanilla, equity index ETFs may present risks that are not always anticipated or fully understood, as evidenced by the events of Aug. 24.”

The Eaton Vance fund works like an actively managed mutual fund: Owners of the ETF share a claim to the stocks the portfolio manager buys. And those holdings remain secret for weeks or months at a time. But unlike a mutual fund, it can be traded throughout the day, not just once daily.

“It’s almost like these were products designed for institutions, but they’re easily available to retail investors,” said Kevin McPartland, head of research for market structure and technology at Greenwich Associates. “It’s certainly something to pay attention to.”

Aug. 24 showed the danger of having inadequate information about what’s going on with the underlying holdings of an ETF. Hundreds of stocks didn’t immediately start trading at the beginning of the day, but ETFs that held them did, effectively untethering the funds from the value of their holdings.

A total of 12 investment managers including Hartford Funds, Pioneer Investments, Gabelli Funds and Victory Capital have agreed to sponsor similar ETFs with the NextShares brand.

‘Better Results’

“We’re not trying to develop product for the sake of developing product,” said Stephen Clarke, president of NextShares. “We’re trying to deliver better results to investors in active strategies.”

Elisabeth Kashner, director of ETF research at FactSet Research Systems Inc., called the new asset class “a solution in search of a problem.” She added: “If you’re in ETF investor, the payoff is unclear.”

No ‘E’

New ways to trade ETFs are sprouting up, too. Tradeweb is sidestepping the “E” in ETF by letting clients buy or sell U.S. exchange-traded funds in private electronic auctions. Over-the-counter trading of ETFs is common in Europe, where markets are more fragmented than in the U.S., and Tradeweb has offered this service there since 2012.

Whereas ETFs began as a way for retail investors to gain exposure to asset classes that are typically meant for more sophisticated traders -- such as oil, gold or corporate bonds -- institutional investors now want more access to the funds, said Adam Gould, Tradeweb’s head of U.S. equity derivatives who oversees its U.S. ETF platform. Similar to block trades, the electronic auction lets a user put up to five dealers in competition for a larger-sized deal than they could get on the New York Stock Exchange or Nasdaq Stock Market.

“That results in better pricing” for investors, Gould said. Yet because the auctions bring two individual investors together for a private trade, they aren’t considered alternative trading systems by the SEC, so they face no government oversight. Tradeweb’s users, however, are required to report the their trades to the Financial Industry Regulatory Authority.

Tradeweb is majority-owned by Thomson Reuters Corp. with minority stakes held by banks such as JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. Bloomberg LP, the parent company of Bloomberg News, competes with Tradeweb in offering ETF-trading services to its subscribers.

The average trade size on Tradeweb’s platform is 90,000 shares, with 55 percent of trades in fixed-income ETFs and 45 percent in equities, Gould said. The speed of the electronic auctions and creating a more-efficient way to conduct and manage the trades after the fact are advantages here, he said.

“A key question is, ‘How quickly do they need to get done?”’ Gould said.

(Corrects 3rd paragraph of story originally published Feb. 26 to remove reference to regulators not seeing the trades.)
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