Active Stock ETFs Move Closer to Market After Long DelayChristopher Condon and Miles Weiss
Companies seeking to push exchange-traded funds into the almost $6 trillion U.S. market for actively managed stock funds are starting to gain traction with regulators after a long delay.
Guggenheim Partners LLC, Eaton Vance Corp. and Precidian Investments have received formal comments in the past two months from the Securities and Exchange Commission staff on plans for new types of actively managed ETFs, industry lawyers and executives said. Similar proposals, some as old as five years, have been on hold at the SEC.
Regulatory approval could clear a path for companies that run active equity mutual funds to sell versions of those products as ETFs, a vehicle that has gained popularity for its cost savings and ease of trading. ETFs have grown to $1.5 trillion in U.S. assets since their introduction in 1993, most of it in passive funds that track an index instead of relying on stock or bond pickers.
“The next wave of ETF sponsors are all going to be mutual-fund companies,” Reggie Browne, head of ETF trading at Cantor Fitzgerald LP in New York, said in an interview. “This is just the tip of the iceberg in terms of the entrance of such strategies.”
Active ETFs combine the security-picking flexibility of a fund manager with the intraday trading and some of the cost-saving characteristics of traditional ETFs. Companies have been discouraged from introducing actively managed versions of equity funds by the SEC’s requirement for daily disclosure of fund holdings, which would make it easy for competitors to copy, and traders to anticipate, a manager’s portfolio changes.
Christina D’Amico, a spokeswoman for the SEC, declined to comment on the proposed products.
The proposals that now have received comment letters from the SEC seek to avoid the daily disclosure of holdings, while offering alternative ways to ensure pricing of the funds remains accurate. Proposals for these funds, known as non-transparent ETFs, were first filed with the SEC five years ago, according to attorney Kathleen Moriarty, who helped develop the SPDR S&P 500 ETF Trust, the first exchange-traded fund in the U.S.
T. Rowe Price Group Inc., based in Baltimore, this week became at least the fifth mutual-fund company to propose a non-transparent active ETF when it filed an application with the SEC. The application “implicitly recognizes the structural changes ETFs are posing for traditional managers,” William Katz, an equity analyst in New York at Citigroup Inc., said in a Sept. 25 note to clients.
“There is a tremendous amount of potential there in terms of the transformative effect this could have on how funds are distributed,” said Ben Johnson, director of passive-funds research at Chicago-based Morningstar Inc.
Transparency is less of an issue on the fixed-income side, where the opacity and negotiated nature of transactions in the over-the-counter bond market protect managers. The two largest active ETFs are the $4.2 billion Pimco Enhanced Short Maturity ETF and the $4 billion Pimco Total Return ETF. Both bond funds, run by Newport Beach, California-based Pacific Investment Management Co., have daily disclosure.
NYSE Euronext, owner of the New York Stock Exchange, plans to submit a draft rule proposal to the SEC within days allowing it to list one of the actively managed ETFs, said two people familiar with the matter who requested anonymity because the request will be confidential.
The exchange’s existing rules wouldn’t permit the listing, according to this person. Katrina Clay, a spokeswoman for NYSE Euronext, declined to comment on active ETF plans.
“We have seen more activity in the past six months than we have seen” in a number of years from the SEC on non-transparent, actively run ETFs, Paul Kuhnle, a principal at Precidian, said in a telephone interview. The firm, based in Bedminster, New Jersey, specializes in structuring and trading exchange-traded products.
There has been progress in talks between would-be providers of non-transparent ETFs and the staff of the SEC toward allaying the agency’s concerns that prices would stray from underlying holding values, Browne said. “It could be perhaps a year before they come out in the marketplace.”
Active ETFs in the U.S. hold $14.5 billion, less than 1 percent of the $1.5 trillion ETF industry, according to data compiled by Bloomberg. Actively managed stock mutual funds in the U.S. oversaw $5.7 trillion as of July 31, according to the Investment Company Institute.
ETFs are baskets of securities that trade on an exchange, like stocks. Investors in most mutual funds can buy or sell shares once a day, typically after markets close, and only directly with the fund.
ETF providers must disclose holdings every day to enable market makers to execute trades that keep the share price in line with the underlying value of the fund’s assets. The disclosure also allows holders to hedge their ETFs by making investments whose value is expected to move in the opposite direction.
Fund companies have said daily transparency makes it easy for opportunistic traders to jump ahead of transactions by an active manager, benefiting from resulting price changes in a tactic known as front-running.
Guggenheim, the investment firm with headquarters in Chicago and New York and more than $180 billion in assets as of June 30, got its first formal set of comments from the SEC within the past several weeks, according to Moriarty, a partner at Katten Muchin Rosenman LLP in New York.
Cary Ruterman, a spokeswoman for Guggenheim at Prosek Partners, declined to comment on the application.
Precidian asked the SEC for permission to open active, non-transparent ETFs in January and recently got comments back from the agency, Kuhnle said, declining to elaborate on the agency’s request.
Eaton Vance, the Boston-based fund company that oversaw $269 billion as of July 31, amended its active ETF application on Sept. 12 after hearing from the agency staff, said Stephen Clarke, head of the Eaton Vance unit behind its proposed funds.
“We are quite encouraged by the progress we feel Eaton Vance has made,” said Clarke, who declined to elaborate on the SEC’s comments.
Eaton Vance’s proposed funds differ from the others. They could be traded all day like stocks, yet with prices set only after the market closes, like mutual funds. Buyers and sellers would submit bid and ask orders relative to the net-asset value at the end of the session, when the new NAV is posted. The firm refers to the product as an exchange-traded mutual fund, or ETMF.
BlackRock Inc., the world’s largest asset manager, is among other firms also awaiting approval for an active, non-transparent ETF proposal. Melissa Garville, a spokeswoman for the New York-based firm, declined to comment on the application’s status.
The first of T. Rowe’s planned funds would be “substantially similar” to the $527 million T. Rowe Price Capital Opportunity Fund, according to this week’s filing. The second would mirror the $18.4 billion T. Rowe Price Blue Chip Growth Fund.
The funds would each disclose a “high-quality pricing signal” every 15 seconds during the trading day in place of revealing holdings, and publish a “hedge portfolio” whose performance “reliably and highly” correlates to the value of a fund’s holdings, T. Rowe said.
Even if non-transparent ETFs get approved, there’s no guarantee investors will take to them, said Geoff Bobroff, a consultant based in East Greenwich, Rhode Island.
“The industry would have to find a way to get scale so the products can be successful,” Bobroff said.