NYSE Gets Custom Basket ETF Edge

NYSE is the first exchange to allow widespread use of custom baskets for semitransparent actively managed ETFs.

Reviewed by: Dan Mika
Edited by: Dan Mika

The New York Stock Exchange has been cleared to allow custom baskets for managers of semitransparent actively managed ETFs, a move that will likely bolster the parade of active launches over the course of 2021.

In a filing last Friday, U.S. Securities and Exchange Commission regulators approved a request from the exchange to preapprove the custom basket option for any active manager seeking to launch a fund that follows the NYSE rules on semitransparent ETFs.

The ruling permits any semi-transparent ETF already trading on the exchange to implement custom baskets, including those using models created by ActiveShares, Blue Tractor, Fidelity and T. Rowe Price.

Custom baskets allow ETF issuers to accept something other than a basket of securities reflecting the exact weighting of their fund, whether it be cash or assets that don’t correspond perfectly to the fund’s portfolio and weightings.

Under the normal creation and redemption process, authorized participants must provide a creation unit resembling the assets and weighting in an ETF’s portfolio to be issued new shares of that ETF.

Fund Friction

While that process works well for index funds, it creates friction for funds in the middle of a rebalancing or recomposition, and for active fund managers seeking to dump a holding and replace it with a different asset.

The ETF Rule that passed in 2019 allowed for actively managed ETFs that disclose their holdings daily to use custom baskets, sparking a flood of new active ETF launches. However, that rule did not apply to the semitransparent actively managed ETFs that started rolling out in 2020. The new rule’s approval will likely bolster the already burgeoning pace of actively managed ETF launches going forward.

Out of the 332 U.S.-based ETF launches as of the end of the third quarter, 197 are actively managed and have garnered nearly $39 billion in assets, according to ETF.com data provider FactSet.

Todd Rosenbluth, head of ETF and mutual fund research at CFRA, says investors are growing more comfortable with using ETFs as tools to outperform indexes rather than only following their returns.

“Additional efforts to put [active ETFs] on par with index-based products will only spur further adoption,” he said.

NYSE Head of Exchange Traded Products Douglas Yones estimates he and his team have spoken to 30-50 asset managers this year alone about launching active funds, and approximately a dozen others are in the pipeline to file for ETFs but have not done so publicly yet.

“We've talked to [several] major active managers in the market over the last three years, and this has come up in [almost] every conversation,” he said.

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Editor's note: This story has been updated to clarify that any ETF using a semi-transparent model approved by the NYSE can use custom baskets.

Dan Mika is a reporter for etf.com. He has previously covered business for the Ames Tribune and Cedar Rapids Gazette in Iowa, and BizWest Media in Fort Collins, Colorado. Dan holds a bachelor's degree in journalism from Truman State University.