Exchange-Traded Managed Funds Fantasy

September 18, 2013

Eaton Vance’s plan for transparent active ETFs is interesting, but looks like it misses the mark.

There’s a buzz going around The Street this week about this newfangled product structure from Eaton Vance and Navigate Fund Solutions called “exchange-traded managed funds” (ETMFs).

I’ve seen at least three Wall St. notes in my email box calling it the next big thing.

Unfortunately, it’s a very old thing, and I think it’s probably dead in the water.

A bit of history: Gary Gastineau is one of the founders of the ETF industry. He came from the Amex, back in the day when the very first ETFs were being launched. He quite literally wrote the book on ETFs, or, at least, wrote quite a good one.

Gary filed a patent in 2005 for a system that would theoretically solve one of the thorny problems with ETFs—transparency.

For most of us, transparency in ETFs is a good thing. Personally, I like knowing what I own. But if you’re an active fund manager, you probably don’t want to be showing your book to your competition—or frankly to your investors, as it can lead to a lot of second-guessing. (You bought Apple where!?)

Gary’s patent finally ended up in the hands of Eaton Vance, which launched a subsidiary called Navigate Fund Solutions to commercialize the patent. They’ve filed for exemptive relief for their newfangled system and, someday, the SEC might approve it.

But is this the savior of the actively managed fund industry, as some are suggesting? I’m not a believer.

Here’s how the ETMF thing is supposed to work. The portfolio manager runs a regular ’40 Act mutual fund, which he could do now as an ETF, with full disclosure.

But instead of showing his full portfolio so authorized participants can do creation/redemption baskets, he publishes a proxy basket he’s willing to use for creations and redemptions. It’s not perfect, and it won’t include any information about what he’s really trading, but it’s “close enough.”

So far so good. The problem becomes trading—if nobody knows what the fund actually holds, how will it trade?

The ETMF envisions an entirely new kind of trading, in which orders aren’t placed to buy a fund at, say, $100, but at net asset value (NAV) plus or minus a premium or discount to that NAV.

Somehow, this combination of proxy portfolios and NAV-based trading is supposed to magically bring Fidelity Magellan into the ETF fold.

Navigate, in its current presentations, is claiming that the above system—because it eliminates shareholder servicing expenses and brings the creation/redemption process to the table—will give actively managed mutual funds chasing the structure a 50-basis-point advantage over where they’re at.



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