Daily ETF Watch: USAA To Copy Vanguard

Mutual fund giant seeks to adopt Vanguard-like approach to ETFs.

USAA, the financial services group that serves current and former members of the military and their families, has filed a new request for exemptive relief regarding ETFs that seems to be modeled after Vanguard’s patented approach to creating ETF share classes out of existing mutual funds.

It’s not clear if Vanguard has licensed this approach to USAA or if the company has found a workaround to the patent. However, the USAA funds are specifically described as actively managed, and it refers to them as “multiclass” funds. The firm originally applied for exemptive relief to launch transparent active ETFs two years ago, and received approval to do so in February 2014.

USAA has yet to launch any ETFs or even put any into registration.

The newest filing also indicates that investors in the USAA funds would be able to convert them back and forth from mutual fund shares to ETF shares.

The filing specifically notes that to avoid investor confusion, USAA will refer to the ETF and mutual fund shares by different names, print separate prospectuses, include explicit disclosures in the prospectuses regarding the nature of the shares, avoid referring to ETF shares as mutual fund investments, avoid joint advertising and implement other additional precautions.

A Bold Step

This latest move by USAA is an interesting one. Providers of actively managed mutual funds have been reluctant to delve into the currently prevailing transparent active ETF realm because of the daily disclosure requirement. Not only will USAA be revealing its ETF portfolios on a daily basis, but those portfolios are likely to reflect the portfolios of the mutual fund shares very closely.

In fact, the firm notes in the filing: “Applicants are aware of the concerns that full portfolio transparency may compound the risk of front-running of Multiclass Fund trades and may also facilitate the ability of outside investors to ‘free ride’ on a Multiclass Fund’s investment strategies.”

However, the prospectus states that because the trades will only be revealed the day after they have been executed, and arguing that the risk of front-running is “expected to be minimal.”

“Applicants intend to carefully consider the impact of full portfolio transparency on a fund when deciding whether to add an ETF share class to such fund,” the prospectus adds.

With Eaton Vance and Precidian in a race to bring to market the first nontransparent actively managed exchange-traded funds—“exchange-traded managed funds” in the case of the frontrunner Eaton Vance—USAA appears to be striking out in a direction all its own. Transparent active ETFs are nothing new, but integrating them into the share classes of existing mutual funds is an unusual step.

The filing did not provide a description or name of an initial fund.