Written by: Daryn Levesque, Associate Director
What are traditional Exchange-Traded Funds (“ETFs”)?
In traditional ETF models, the issuer publishes its portfolio to the NSCC, making portfolio composition files available to dealers. Large institutions called Authorized Participants (“AP”) use the composition files to create new shares of the ETFs (by gathering necessary securities in the market and delivering them in-kind to the fund) or redeem shares of the ETF (by gathering shares of the ETF in the market and delivering them to the fund in exchange for the portfolio securities). This marketplace creates a tax-efficient mechanism with daily transparency as the portfolio is also disclosed daily on the fund’s website.
What are Active Semi-Transparents and what do they accomplish?
Recently, the SEC approved models that allow for reduced daily transparency or disguise the holdings in some manner. Active managers in traditional fund structures, such as mutual funds or separately managed accounts, who wish to keep their strategies secret and avoid being front-run can use these less transparent models to safeguard intellectual property.
What are the different models currently available to the market?
Blue Tractor Shielded Alpha
Holdings and weightings are disclosed, but disclosed weightings deviate 10% from actual weightings.
Eaton Vance ClearHedge
Discloses a basket of liquid interests designed to have a high degree of correlation to the fund itself. The ETF’s actual holdings and weightings are shielded from public view. A swap administration agent stands ready to issue new swaps every second over the course of the trading day, which can be used to swap the performance of the actual underlying securities.
Fidelity Tracking Basket
Discloses a Tracking Basket designed to closely track the daily performance of the ETF’s actual portfolio. The ETF’s actual holdings and weightings are shielded from public view.
New York Stock Exchange/Natixis Proxy Portfolio
Discloses a proxy portfolio designed to recreate the daily performance of the actual portfolio using a factor model analysis of the ETF’s actual portfolio. The ETF’s actual holdings and weightings are shielded from public view.
Trusted agents, also known as authorized participant representatives (APRs), use confidential accounts to execute creations and redemptions for authorized participants. The portfolio is required to be disclosed at least quarterly.
T. Rowe Price Proxy Portfolio
A proxy portfolio is disclosed to the public, with holdings that exhibit a high correlation to the fund’s true underlying holdings.
Is this right for my firm/what to consider?
There are many considerations to make before an asset manager decides if this structure is a good fit for their firm. One item to consider is choosing one of the models. Foreside suggests speaking with representatives from all licensers before deciding upon one. Firms should also create detailed, thorough, and specific distribution plans while considering how the product fits in a portfolio and the target market. Not all APs nor secondary-market platforms will engage products utilizing these wrappers, so having growth strategies is imperative. Firms also need to consider that changing product structure will not necessarily lead to success. A poorly performing strategy will not become better just because it is in an ETP structure despite the rush of assets to ETPs in general. Firms should stand ready to deliver and explain additional details or questions posed by APs and other market participants beyond strategy and holdings. These firms will want to understand the chosen model, how to handle restricted securities, and the other parties involved.
How can Foreside help?
Foreside helped launch the first active non-transparent ETPs for both the Precidian and NYSE models. We have since helped firms launch additional semi-transparent models such as Fidelity’s and remain agnostic in our ability to help any model come to market. Foreside maintains an extensive level of industry knowledge and stands ready to share this information to help our clients focus their outreach and ensure a smooth and successful launch.