Mutual Funds Take New Routes To ETFs

January 24, 2014

More and more firms are finding new ways to get a piece of the ETF action.

Two mutual fund firm stalwarts, TCW and MFS Investment Management, are finding new ways (short of creating and launching their own funds) to bring exchange-traded funds—usually active strategies—to market, by teaming up with existing issuers, at a time ETFs are taking off.

To be sure, a plethora of mutual fund firms and insurance companies have begun laying the regulatory groundwork to offer their own ETFs in the past few years, most recently, the insurer Prudential. But precious few—with the exception of Pimco, Fidelity and most recently, Franklin Templeton—have actually launched ETFs.

That said, Fidelity has done both—it now has a small and growing family of proprietary ETFs, and it’s in a partnership with iShares to create index ETFs, use iShares ETFs in Fidelity managed accounts and allow 65 iShares ETFs to trade commission free on the Fidelity platform.

In all the maneuvering, what is totally clear is that since the first ETF came to market 21 years ago, the world of ETFs continues to slowly and steadily expand, with $2 trillion in assets under management now in sight. That’s far less than the $13 trillion in open-end mutual funds or the $6 trillion in hedge funds, but the writing’s on the wall, and no one wants to be left out.

State Street And MFS

This month, State Street Global Advisors launched three actively managed equity ETFs in partnership with MFS Investment Management—the very firm that launched the world’s first mutual fund in 1924.

Both firms are touting the new ETFs as beneficial to investors because of “a focus on managing downside risk.” The launches come at a time when interest rates are rising and the Federal Reserve is pulling back on its five years of monetary stimulus.

The three new ETFs include:

The funds’ annual expense ratios are each 0.60 percent, or $60 for every $10,000 invested—not dirt cheap as ETFs go, but a lot less expensive than the average mutual fund.

Dan Flaherty, a spokesman for MFS, said the firm currently doesn’t have any plans to get into the ETF business directly or subadvise on other funds.

“We saw an opportunity with some strategies that had not gained traction in the high net worth and separately managed accounts area,” said Flaherty.

“We do remain dedicated to our core strategy of actively managed products and we viewed this as an opportunity to leverage an existing capability that we had and to take advantage of what we see as a developing trend in active ETFs,” he added.

Emerging Global And TCW

Also, Emerging Global Advisors—the purveyor of the $1.25 billion EGShares Emerging Markets Consumer ETF (ECON | D-51)—made a splashy start in the fixed-income space by launching a trio of emerging-market investment-grade bond ETFs with the TCW Group.

The new bond funds include the:

  • EGShares TCW EM Short Term Investment Grade Bond ETF (SEMF)
  • EGShares TCW EM Intermediate Term Investment Grade Bond ETF (IEMF)
  • EGShares TCW EM Long Term Investment Grade Bond ETF (LEMF)

TCW currently manages some $10 billion in emerging market debt spread across four active mutual funds and separate accounts. But it’s a newcomer to the ETF space and will subadvise the funds.

Penny Foley, group managing director of Emerging Markets Strategies at TCW, said that since this is a new product market for the firm, there are no decisions yet to incorporate ETFs into its mutual funds or separate accounts, or launch its own ETFs going forward.


Plans And More Plans

The cautious, one-step-at-a-time way that both MFS and TCW are proceeding is emblematic of the overall cautiousness exhibited by many firms signaling they want to enter the world of ETF sponsors. As noted, it seems many petitions to gain permission to offer ETFs might be gathering dust for now.

Like Prudential—which revealed in regulatory paperwork that it wants to bring to market an actively managed fund called the Prudential Core Bond ETF—most companies contemplating an entry into ETFs are more focused on bringing active strategies to market than passive ones.

Among the more interesting ideas in the realm of nontransparent active ETFs aimed at protecting a manager’s investment ideas, is one from Eaton Vance.

The Boston-based firm is looking to offer what it calls exchange-traded managed funds, or ETMFs, which are in some ways like open-end mutual funds. Like an ETF, and ETMF could trade all day; but like a mutual fund, it would only price once a day, using what the company calls NAV-based trade.

In NAV-based trading, prices would vary from NAV by a market-determined premium or discount, which could at times be zero, according to Stephen Clarke, president of Navigate Fund Solutions, an Eaton Vance subsidiary that will license the ETMF patent to other mutual funds once the exemptive relief is approved by regulators.

“We’ve been asked by regulators to be clear that an ETMF is not an ETF,” said Clarke, in a recent call with IndexUniverse analysts and reporters. “There are a few other companies that have filed for active, less-than-transparent ETFs, but we’re the only company that has filed for ETMFs.”

Regulators haven’t yet signed off on the company’s latest plan, but rumors are swirling that approval might be imminent. The company is rumored to have plans to replicate all of its existing mutual funds in an ETMF wrapper, which will have tax efficiency similar to an ETF.

Faith In A Blind Trust


Another idea that’s been floating out in regulatory purgatory for more than two years is based on a patent owned by New Jersey-based Precidian Investments.

Precidian, which has licensed the idea to both BlackRock and State Street Global Advisors, is proposing a nontransparent active ETF that would make use of a blind trust in the creation/redemption mechanism that is at the center of every ETF.

The blind trust would work on behalf of the authorized participant that would keep disclosure of portfolio holdings under wraps until regulators require it. To put that in context, existing mutual funds must disclose holdings every three months, with a lag, and it appears Precidian’s plan would include disclosure requirements similar to those in place for mutual funds.

Precidian this week filed in a prospectus detailing the first three nontransparent ETFs that could go long or short that it hopes to bring to market. They include:

  • ActiveShares Large-Cap Fund, which will invest in stocks included in the Russell 1000 Index;
  • ActiveShares Mid-Cap Fund, which will invest in stocks that are included in the Russell 2000;
  • ActiveShares Multi-Cap Fund, which will invest primarily in securities included in the Russell 3000 Index and ETFs

Under normal market conditions, its net long equity market exposure will not exceed 100 percent, and its net short equity market exposure will not exceed 30 percent. However, the portfolio managers may at times exceed these percentages, according to the filing.

Crucially, the plan doesn’t yet have the benediction of the Securities and Exchange Commission, but industry sources reckon Precidian must be making headway at the SEC, or it wouldn’t have filed the fund prospectuses.

The New York Stock Exchange has filed a request with the SEC to adopt a new rule that would permit “nontransparent” ETFs to list and trade on its platform. Specifically, the NYSE’s filing requested permission to list and trade Precidian’s three new funds.


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