I remember the first time I predicted that “this was the year” for nontransparent active ETFs. It was 2013.
Every year since, I’ve consistently believed the approval of one specific structure—the Precidian ActiveShares
filings—would be approved “any day now.” So while I guess I should give up any aspirations as a predictor of actual events, I’ll take some solace in knowing I at least got the “winner” of the race to get an NTA structure approved. I never really had a doubt.
Under The Hood
The reason I was so confident isn’t because I’m a genius. Far from it. The reason I was confident is because at its core, the ActiveShares structure is so simple. If you understand how a regular ETF works, it just adds a single new moving part: the trusted agent.
In a normal ETF, an authorized participant notices that an ETF is trading at a premium, and they make an arbitrage trade: selling the “expensive” ETF while buying a basket of underlying holdings. At the end of the day, they deliver the basket, and they get new ETF shares to settle the ETF sales.
In the ActiveShares model, the AP still watches for a price discrepancy, but instead of building their own model of what the ETF should be trading at in real time, they rely on a new, high-accuracy real-time net asset value. When they see the arbitrage opportunity, they still sell the “expensive” ETF shares. But instead of buying their own basket, they authorize a trusted agent to buy it for them. The agent gets to know what the real portfolio is on a confidential basis, instead of the AP themselves.
It’s really that simple.
Chicken Vs. Egg
So why did it take so long for the SEC to get comfortable? For the same reason it took so long for it to get used to the ETF structure in the first place, back in the 1990s. Fundamentally, ETFs suffer from a chicken and egg problem: There needs to be enough trading activity for it to be worth an AP’s time to play ball, but investors won’t be interested unless they’re sure pricing is relatively fair and there’s enough liquidity. The first time I heard about ETFs, my brain couldn’t get past this chicken/egg issue, and I was enormously skeptical (and wrong then too!).
So the last six years have been a dance—tweaking this, explaining that, building support in the trading community. And finally, we’re on the very brink of these things being in the wild.
Will Anyone Care?
This remains the greatest unknown. There’s absolutely no question that the ActiveShares structure solves a problem for active fund managers: They’ve got a passel of strategies they firmly believe would wilt under the light of full transparency. There’s no doubt in my mind that this time next year, there’ll be dozens of new active funds competing for investor dollars.
But here’s the thing: Investors have been voting with their pocketbooks for the past decade, consistently pulling money from active mutual funds and putting money into low-cost, predominantly index-based ETFs. Will the efficiency and tax advantages of ETFs be enough to lure them back? I remain, as always, a skeptic.