Another Active ETF(ish) Shoe Drops

August 11, 2016

There’s been a lot of back and forth on active ETFs lately. Active ETFs still make up a very small portion of the ETF market, because currently the only approved structure for such a beast is a fully transparent ETF with daily disclosure of holdings.

Many investors think all ETFs disclose their daily holdings by default, but that’s actually a myth.

Vanguard, for instance, just discloses its holdings on the same schedule as the mutual funds of which its ETFs are share classes of—monthly, with a 15-day lag. So you get to see the July 31 portfolio on Aug. 15.

The company gets away with that because it’s tracking indexes, and Vanguard has a reputation for tracking those indexes extremely tightly, so even though authorized participants (APs) don’t “know” exactly what’s in, say, the Vanguard S&P 500 ETF (VOO), investors have, to say the least, a pretty darn good guess to hedge from.

Different Rules For Active Than Passive

To date, because active ETFs can hold literally anything on any given day, the SEC has insisted that ETFs show the market their full portfolio, so the market will be better able to arbitrage out any price discrepancies between the fair value of the holdings and the actual trading price.

Most of the funds that are willing to do this are big bond funds like the PIMCO Total Return Active (BOND) and the SPDR DoubleLine Total Return Tactical ETF (TOTL). The thinking is that those funds rely on such incredible scale and access that no “normal” investor could ever efficiently front-run them.

Getting a true “nontransparent” active ETF approved by the SEC has been a bit of a holy grail in the ETF Nerd Club (disclosure: founding member). There have been proposals from Precidian, T. Rowe Price, Blue Tractor and Eaton Vance all trying to crack this particular nut, all with varying ways of “blinding” the portfolio from the market while still trying to maintain arbitrage.

The Fidelity Plan

This morning, Fidelity filed a new application that goes even farther toward just running money transparently. The company’s proposal adds a few new wrinkles. Here are the highlights:

  • The fund is not a traditional ’40 Act mutual fund under the hood, as are the vast majority of ETFs, but is instead built around a closed-end fund (CEF) structure.
  • The fund would disclose its full portfolio every 30 days, with a 30-day lag.
  • The fund would publish a daily “tracking basket” that is used to calculate intraday net asset values (iNAV), and is also always the security list used for all creations and redemptions.

So far this is pretty straightforward stuff, and the arbitrage mechanism doesn’t seem radically different than the original proposal from T. Rowe Price back in 2013 (minus the closed-end fund part). T. Rowe Price envisioned basing the iNAV of true holdings, and put some boundaries on the tracking basket (called a hedge portfolio, in T. Rowe’s case).

If anything, the Fidelity filing is a simpler version of similar concepts.


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