The recent news regarding the Precidian ActiveShares® filing provides a light at the end of the tunnel for active managers who want to leverage the ETF wrapper. Read on for more insights from the ETF Product Team at BNY Mellon.
Persistence has paid off for Precidian Investments™, as the SEC’s Division of Investment Management officially granted approval for the innovative ActiveShares line of non-transparent active ETFs. A journey that began over six years ago will soon open up exciting opportunities for active managers looking to participate in the ETF growth movement.
It’s fitting that ETFs, which have led to the democratization of many investment strategies over the years, may soon further evolve the active space. Lower cost, greater tax efficiency, intraday liquidity, and daily transparency are key advantages inherent in the traditional ETF wrapper. Precidian ActiveShares products are designed to retain many of these advantages, while limiting the transparency that (although beneficial to a passive product) can potentially lead to the front-running or cloning of proprietary active strategies.
Let’s take a look at the four main structural advantages of an ETF and how they play out in this new product type.
Because ETFs trade on an exchange, the administrative costs associated with running a fund shift from the product manufacturer to the brokerage house under the ETF structure. These costs take many forms—from client service staffing to investment related reporting—and typically result in a lower expense ratio on average for an ETF versus a comparable mutual fund. There are also bid/ask spreads to consider when trading ETFs, which are impacted by a number of factors, including general market volatility as well as the liquidity of the underlying investments. However, even when factoring in these additional costs, the total round trip1 cost of ETF ownership still tends to be much less expensive than a comparable mutual fund.
The ActiveShares structure benefits from the same explicit cost advantages, while reducing implicit spread concerns, by offering a new form of intraday NAV calculation called a VIIV (Verified Intraday Indicative Value). The VIIV is calculated more frequently than on transparent ETFs today.
The operational model that supports ETFs in the U.S. enables an exchange of securities and cash “in-kind” in return for an ETF. This “in-kind” mechanism allows ETFs to postpone capital gains in the short term on redemptions, aligning the ETF holder’s investment decisions with the timing of the tax bill. Mutual fund investors can sometimes be blindsided by turnover within the fund strategy generating capital gains, even if the mutual fund investor never sold shares.
The ActiveShares structure retains the “in-kind” feature by creating a new market participant called an Authorized Participant Representative (AP Rep). The AP Rep keeps the basket of securities involved in the transaction (and hence the strategy) secret by delivering them from “confidential accounts” to the fund, ultimately delivering ETF shares to traditional Authorized Participants in exchange for cash.
Because ETFs are simply equities trading on an exchange, they retain the trading flexibility of typical equity investments. You can go long and short on ETFs, buy or write options, and take advantage of market inefficiency to reap arbitrage returns with an ETF. For a mutual fund, you can only buy or sell the shares at the end of the day at Net Asset Value pricing.
ActiveShares products offer the intraday flexibility of a traditional ETF, while utilizing existing infrastructure and equity market structure rules. Leveraging of existing setup minimizes the costs required by the equity ecosystem to support this new model.
In existing transparent active ETFs, there is a trade-off between daily transparency of fund holdings and revealing the investment strategy. Mutual funds are required to publish holdings only periodically, typically once per month or quarter, which is thought to provide better protection for a fund manager’s “secret sauce.”
The ActiveShares model reduces daily transparency by leveraging a similar mutual fund-like disclosure cadence. Pairing the periodic disclosure with the VIIV is how Precidian splits the difference between the strengths of both models.
The next stage in the approval process is for the SEC’s Division of Trading and Markets to review and approve listing rule changes that must be filed by the exchange of choice, known as a 19b-4, as well as changes to Regulation M relief. This approval stage is separate from the SEC’s Division of Investment Management review and can range from 45 to 240 days.
With significant assets flowing into the ETF structure, active managers concerned about transparency may soon be able to take advantage of the “better mousetrap” with new non-transparent or partially-transparent models, such as Precidian ActiveShares.
As new innovation within the ETF space hits the market, BNY Mellon is continually developing best-in-class capabilities. We have been collaborating with Precidian and other non-transparent models on an ongoing basis to define the ideal operating structure. Our NEXEN ETF Center portal is a vital gateway to serve the needs of a new form of market participant – the AP Rep.
Our proven, full-service suite of basket creation and execution services, as well as order placement, valuation and settlement capabilities provide the foundation for the next evolution of ETF Services. Our platform has supported the growth of the ETF industry for over 20 years by managing back and middle office solutions for over 1,000 ETFs and $600B in assets in 2019. Our global electronic order submission option will be another advanced tool to allow APs to quickly access and hedge ActiveShares ETFs. We are excited to share our enhanced platform with new and existing ETF partners.
For more information, please reach out to the ETFProduct@BNYMellon.com or your current relationship manager.
1Round trip constitutes the total cost for an investor to both buy and sell the ETF
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