American Funds ETF Filing A Very Big Deal

July 28, 2014

The Blind Trust Structure

The second reason this is a big deal is that it's the de facto checkered flag to see which of the competing structures for nontransparent active ETFs will win. I've written quite critically before about the "Exchange Traded Managed Fund" alternative being proposed by Eaton Vance and its Navigate Fund Solutions unit. It adds a whole new kind of trading to the market and requires significant changes in both authorized participants (APs) and investor behavior. I wasn't sanguine on its chances.

The alternative structure, designed by Precidian Investments, is significantly simpler.

In a nutshell, it solves the transparency problem by putting a blind trust in between the AP and the ETF itself. You want new shares? You give cash to the blind trust, it goes and buys a secret list of stocks, in-kinds them to the ETF, and you get shares at the end of the day at NAV.

You want to redeem shares? You hand them to the blind trust, they get the redemption basket from the ETF, likely sell the securities, and hand you cash back. There are nuances, but that's pretty much it.

The Precidian concept is not without its own issues.

Because the market doesn't know exactly what's in the ETF, players buying and selling such ETFs have to guess at what they can hedge against any exposure they have between now and the end of the day, when creations and redemptions are processed at net asset values (NAVs). This likely leads to slightly wider spreads around fair value, though they'll still likely around that same 15-second distributed iNAV.

The elegance of the system is that nobody has to learn how to do anything differently, except APs making a "risk market" for the shares. But, hey, that's their job anyway.

The Elephant In The Room

While a clear win for the Precidian version of nontransparent active (and likely a sign that the SEC is moving closer to approval on the first batch, an idea strengthened by the fact the filer, Paul Roye, used to run the Division of Investment Management at the SEC), I still have the same reservations I've always had about nontransparent active, and that is that it's active, period.

Whether American Funds or BlackRock or anyone else is successful launching nontransparent active ETFs will have less to do with whether the structure works and a lot more to do with whether a particular flavor of active management actually delivers superior risk-adjusted returns over tried-and-true index management.

But then again, I guess that's how it should be, and how ETFs have always made things.

ETFs, as a structure, should really be about getting the structure out of the way. I still think low-cost indexing is probably a better solution for most investors, but I welcome the rest of the investment management world into our little pond in the sea of mutual funds. Come on in, the water's fine.

At the time this article was written, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].




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