Precidian Plans Nontransparent Active ETFs

February 08, 2013


Transparent Active Funds

Precidian’s and BlackRock’s plans amount to radical departures from actively managed strategies to date.

As it stands, the SEC requires daily disclosure of portfolio holdings of active ETFs, and most indexed ETFs choose to disclose their full holdings daily.

Companies like Pimco and WisdomTree have had some success gathering assets in such actively managed strategies that disclose holdings daily.

The most successful funds thus far are in the fixed-income space, such as Pimco’s BOND, and the Pimco Enhanced Short Maturity Strategy (NYSEArca: MINT), which has $2.6 billion, according to data compiled by IndexUniverse. Additionally, the WisdomTree Tree Emerging Markets Local Debt Fund (NYSEArca: ELD) has gathered more than $1.76 billion.

As things stand, less than 1 percent of the $1.425 trillion in total U.S.-listed ETF assets is invested in active strategies.

A Nontransparent ETF Future?

Boston-based Eaton Vance, as noted, has said it’s planning to market nontransparent ETFs using patents it obtained when it acquired Managed ETFs, a company owned by longtime ETF industry consultant Gary Gastineau.

The Eaton Vance plan centers on the use of trading based on a fund’s end-of-day NAV.

NAV-based trading allows managers of nontransparent funds to trade securities throughout the day at prices determined at or relative to NAV values calculated on that day.

It’s an idea that makes some advisors wonder whether the trading efficiency of ETFs might be compromised if intraday purchases and sales wouldn’t be definitively priced until the end of the session.

A Different Ball Of Wax

The disclosure requirements described in the Precidian and BlackRock filings seem to be much closer to currently prevalent disclosure requirements for mutual funds.

That’s significant because a number of industry sources say that the many mutual fund companies that have made tentative steps to begin offering exchange-traded funds might leap head-first into the ETF business if they could keep their portfolio disclosures to a minimum, as they do now.

Mutual fund companies are also said to be loath to transition assets from existing funds into cheaper funds. Moreover, much of the mutual fund industry’s success is predicated on a well-oiled distribution machine.

That means that assets segueing into ETFs—where distribution infrastructure is relatively undeveloped—would mean the mutual fund industry would lose contact with many of its end investors.

More Mechanics Of Nontransparent ETFs

Regarding creations in the proposed structure, the Precidian filing—again with the exact same language as the BlackRock filing—said:

“Since Creation Units will be created solely by the deposit of cash and will typically be redeemed by distributing securities of the fund’s portfolio to a blind trust that will liquidate the portfolio securities in accordance with instructions from the authorized participant redeeming shares, neither the adviser nor the fund sub adviser will be able to cause an authorized participant to engage in transactions in which the funds could not engage directly or to otherwise use the in-kind process to circumvent applicable restrictions under the Act.”

Also, when ETF shares are liquidated, the AP would receive cash—again, never knowing what made up the ETF shares that the blind trust redeems.

Crucially, the blind trust becomes a part of the creation and redemption mechanism that is at the center of how an ETF functions. Because that doesn’t change, that means tax inefficiencies and cash drag that are the Achilles’ heels of many mutual funds are likely to be neutralized under the proposed structure.

When faced with redemptions, the fund would have two choices of response: It could raise cash at the fund level if it has a loss it wants to lock in for tax reasons, or it could hand out shares in-kind to the blind trust that would then liquidate shares on behalf of the AP.


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