Transparency Vs. ‘Tyranny Of Benchmarks’

July 07, 2017

"If [ETF] daily known holdings become less transparent, it's a problem for market makers to maintain an orderly market," noted Schreiber. "Spreads will widen, because market makers must take on more risk."

To be fair, not all ETF issuers are bothered by the SEC's disclosure requirements.

"I always wonder if it's a red herring," said Ryan Issakainen, senior VP and ETF strategist for First Trust. The firm offers 28 fully disclosed active ETFs totaling $9.3 billion in assets—roughly one-quarter of all active ETF assets. "Many [managers] say they can't do what they want in a transparent structure, but we disclose our holdings every day and still have managed to build robust funds."

Yet many of the biggest names in the mutual fund industry have dragged their feet on launching ETFs. That's why some companies have attempted to lure recalcitrant managers with hybrid products that alchemize nondisclosure with exchange-trading in the hopes of satisfying investors, issuers and regulators alike.

Arbitrage Via Middleman

By our count, Precidian Investments is the only company promising a truly nontransparent active ETF, though BlackRock, State Street and PowerShares have filed for their own versions based more or less on the same idea.

ActiveShares would solve the transparency issue by reporting fund holdings only when required to; namely, once a quarter, like mutual funds. 

To facilitate market-making, however, the structure would establish a confidential account between the AP and the ETF, managed by a middleman broker. (Formerly, this was called a "blind trust," but the company has since dropped that language after SEC objections.)

If an AP wants new ETF shares, she gives cash to her broker, who goes out and buys a secret list of securities on her behalf, then performs the in-kind exchange with the ETF company that currently APs do themselves. The AP would receive her shares at the end of the day, priced at the ETF's net asset value (NAV).

Redemption works similarly: The AP would give her ETF shares to her broker, who'd exchange them for the underlying securities, sell them on the open market, then give the AP cash.


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