In Search Of An Active ETF Model

January 16, 2014

Despite growing interest, there’s no standard model for exchange-traded funds that aim to outperform


[This article originally appeared on our sister site,]

Most exchange-traded funds (ETFs) are rules-based, aiming to track an index. But many fund operators are now looking to marry discretionary active management with an exchange listing, seeking to capitalise on the ETF boom.

In the US, the securities market regulator has so far permitted so-called “active ETFs” to be launched only under a stringent condition—the daily disclosure of portfolio holdings. This has prevented many active fund managers, who regard such information as market-sensitive, from seeking to launch ETF versions of their strategies. While most index-based ETFs in the US also show their holdings daily, legally they are only required to do so each quarter.

Now, however, the SEC faces a lengthening backlog of requests to approve non-transparent active exchange-traded funds (ETFs), which would reveal their holdings less frequently and with a lag. If such applications are given the green light, a flood of exchange listings by the leading active fund issuers could follow.

In Europe, where mutual funds have been traded on stock exchanges since the 19th century, both transparent and non-transparent active ETFs already exist. By contrast with the US, EU regulators set no specific disclosure requirements for this type of fund.

Non-EU Switzerland does not currently permit ETFs that are based on discretionary management strategies, though this may soon change, according to market contacts.

Confusingly, this side of the Atlantic there’s also a significant number of actively managed funds that are not called ETFs but which resemble them by being exchange-traded. Such funds are bought and sold by investors on the region’s stock exchanges as an alternative to dealing directly with the fund issuer or with intermediaries such as financial advisers or fund platforms.

Around 3000 active mutual funds are traded in real time on Frankfurt’s XETRA market, for example, over double the number of ETFs listed on the exchange.

Trading funds on-exchange not only offers investors immediate knowledge of the execution price, but can also promise cost advantages: although investors face a spread between market makers’ bid and offer prices for fund units, they may be able to avoid paying a front-end load (initial charge) to the fund issuer by using the exchange for their purchase.

Surprisingly, given the growing popularity of the ETF label, some of those connected with the listed mutual funds business don’t want to be associated with it. When Europe’s securities regulator, ESMA, issued consultations about ETFs in 2011 and 2012 with a view to bringing in new regulations, the Danish Fund Association made it clear that it viewed its stock exchange’s traded fund segment as distinct from ETFs.

The mechanisms for European exchanges’ non-ETF fund trading segments vary. Some resemble the traditional mutual fund model of settling deals on a forward pricing basis, taking orders by a regular cut-off point and informing investors later of the price at which deals have been struck.



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