SSgA Seeks Active Nontransparent ETFs

June 11, 2013

 

Inner Workings

Under the plans proposed by State Street, BlackRock and Precidian, APs for such nontransparent active ETFs would effectively be doing creations and redemptions for cash and hedging the funds based on the fact that they could redeem shares for the exact cash value of the funds’ net asset value (NAV).

Creations and redemptions would happen in kind in the blind trust, allowing the fund to enjoy some of the tax efficiencies that transparent ETFs currently enjoy.

Crucially, the blind trust would be able to do what APs at the center of any index-based ETF are able to do, such as eliminating higher-cost securities to get rid of imbedded capital gains at the fund level. Such cherry-picking of securities is a key reason ETFs are considered to be more tax efficient than mutual funds.

Regarding creations in the proposed structure, the State Street filing—with the exact same language as the BlackRock filing—said:

“Since Creation Units will be created solely by the deposit of cash and will typically be redeemed by distributing securities of the fund’s portfolio to a blind trust that will liquidate the portfolio securities in accordance with instructions from the authorized participant redeeming shares, neither the adviser nor the fund sub adviser will be able to cause an authorized participant to engage in transactions in which the funds could not engage directly or to otherwise use the in-kind process to circumvent applicable restrictions under the Act.”

Also, when ETF shares are liquidated, the AP would receive cash—again, never knowing what made up the ETF shares that the blind trust redeems.

Crucially, the blind trust becomes a part of the creation and redemption mechanism that is at the center of how an ETF functions.

Because that aspect remains the same, that means tax inefficiencies and cash drag that are the Achilles heels of many mutual funds are likely to be neutralized under the proposed structure.

When faced with redemptions, the fund would have two choices of response: It could raise cash at the fund level if it has a loss it wants to lock in for tax reasons, or it could hand out shares in-kind to the blind trust that would then liquidate shares on behalf of the AP.

 

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