Fidelity Hedges Its Active ETF Bet

September 30, 2014

Without much fanfare, Fidelity throws its hat in nontransparent active ETF ring.

In all the hubbub about PIMCO over the last few days, Fidelity may have actually made one of the more interesting ETF moves in the traditional active management space. Last week, the firm filed paperwork with the SEC to run nontransparent actively managed ETFs.

What’s interesting—at least to an ETF nerd like me—is that Fidelity didn’t choose one of the two big competing structures; it took a third path.

The Blind Trust

Most of the industry has thrown its weight behind a Precidian Investments-based blind trust model for nontransparent active ETFs. That’s what where BlackRock, SSgA and American Funds (just to name a few) are headed.

In the blind trust model, authorized participants (APs) don’t actually deal with the fund company at all; they deal with the trust, and that trust handles generating or disposing of the creation/redemption basket with the fund itself.

It’s an elegant structure that preserves all of the tax and transaction-cost advantages of traditional ETFs. The trade-off is that the Street doesn’t know exactly what’s in the portfolio, which makes it a little more difficult to hedge creations and redemptions.

Even if enormously successful, my prediction is that the Precidian-based products will have slightly wider spreads in the open market to account for this information slippage.

The Hybrid

The competing structure, proffered by mutual fund company Eaton Vance, abandons the traditional market altogether; in fact, Eaton Vance doesn’t even call them ETFs, it calls them “exchange traded managed funds.”

ETMFs would not disclose holdings and would trade in a new way—a premium or discount to NAV.

APs would have some sense of what NAV will be because Eaton Vance (or anyone else using the ETMF structure) will put forth a proxy basket that is supposedly good enough.

I’ve been less than kind to the idea that the Street is going to learn a whole new way to trade just to accommodate these things. But hey, it’s a free market, and the best structure will win.





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