Swaps Can Add Illiquidity
Generic listings standards allow actively managed ETFs to use a certain level of these derivatives, but obtaining swaps contracts can be expensive and difficult, since it requires venturing into the over-the-counter markets.
Swaps are written on a customized basis for nonstandardized amounts and terms, and must be traded via margin accounts. Due to the increased difficulty in procuring them, ETFs using swaps tend to possess higher trading spreads.
Furthermore, little is publicly available about the particular swaps contracts YOLO uses, which, as of Aug. 9, comprise 17.2% of its portfolio. It is unclear how liquid they are or who their counterparties may be, or what would happen should they default on their agreements.
‘Very Large, Very Liquid’
Ahrens declined to comment on the counterparties or other specifics of YOLO's swaps contracts, instead stating that, "Any stock we're getting exposure to through a swap is still an exchange-listed stock; very large, very liquid."
Some of the swaps YOLO uses are indeed for "very large, very liquid" stocks, such as Cresco Labs, which has a $135 billion market capitalization.
However, YOLO also uses the swaps of smaller companies, like Trulieve Cannabis, which has a market cap of $1.1 billion, or Ianthus Capital Holdings, which has a market cap of $231 million.
Still, added Ahrens, "We are being selective about which [contracts] we're adding. We want access to most of the biggest and the best."
Unusual Create/Redeem Process For MJ
But what about MJ, the oldest and largest marijuana ETF, and the fund that sparked this investigation so many months ago? Interestingly, MJ possesses its own potentially complicating set of circumstances surrounding creation/redemption; yet, according to the data, its unique setup appears to have had little concrete impact on its spread.
To create and redeem shares of an ETF, APs generally rely on what's known as a portfolio composition file (PCF), which tells them which securities to buy/sell and in what amounts. Updated on a daily basis, PCFs are uploaded to the National Securities Clearing Corporation (NSCC)'s website and made available for APs to download. The vast majority of ETFs participate in this process.
ETFMG, though, does not post its PCF to the NSCC website; it hasn't for nearly a year, not since it suddenly switched its custodian and transfer agent to Wedbush Securities and Computershare Trust Company, respectively (read: "Marijuana ETF Shifts Custody").
Instead, MJ's PCF is available for download only on the fund's website, under the tab labeled "Basket."
Transfer Agent Not NSCC Member
Given how many of the securities in MJ overlap with those in YOLO, THCX and TOKE—all of which post their PCFs to the NSCC website—the motivation behind not posting MJ's PCF is likely not the underlying securities.
Instead, it may have to do with the fact that MJ's transfer agent, Computershare, is still not a listed member of the NSCC. Transfer agents are the fund servicers responsible for processing the actual creation/redemption of new ETF shares, as well as maintaining records of creation/redemption activity. They are also usually the party that uploads the PCF to the NSCC.
We first reported on Computershare's lack of NSCC membership last September (read: "Strange Case Of Premiums For Pot ETF"). It appears that the company still has yet to obtain NSCC membership, as of the August member update.
Neither the NSCC nor Computershare immediately returned requests for comment. Wedbush Securities, MJ's custodian, declined to comment on this article.
MJ: Trading Spreads Still Relatively Narrow
Regardless, the unorthodox method in which ETFMG makes MJ's basket available to APs does not seem to have hurt its trading spreads. MJ has the second-lowest trading spreads of the four cannabis ETFs examined.
Despite initially responding to request for comment, ETFMG did not respond in time for publication. We will update this article when we hear more.
"They do things a little differently," said Esposito, who was the previous owner of ETFMG, and has worked with the firm closely since its sale. "They did that in order to grow [the ETF] and to take it off U.S. Bank's platform and onto Wedbush's. I'm not an expert on the nuance, but clearly it's worked."
Contact Lara Crigger at [email protected]