Saturday, 02 August 2014 07:30
On Friday, a new petition seeking the right to offer non-transparent active ETFs titled "The Capital Group ETF Trust" went into the regulatory pipeline at the Securities and Exchange Commission. It might be the biggest ETF story of the year.
That filing follows the fairly standard boilerplate we've seen from State Street, BlackRock and Invesco PowerShares. That boilerplate points to the ETF structure being put forth by Precidian investments, which itself has also filed to run nontransparent active ETFs.
There are several reasons this is enormously big news.
It's American Funds
Don't let the name fool you, the Capital Group is the actual company behind American Funds, a $1.1 trillion juggernaut of traditional active management. We've been on the record for some time saying it was just a matter of time before one of the big, single-focus active management companies like American Funds, Janus or Gabelli jumped into the nontransparent active arena.
But if there were a clear one you'd want to see as the signal, it would be American Funds. Why?
Consider what the top 20 traditional mutual funds are in this country as of this morning:
|Ticker||Name||Assets ($, M)|
|VTSMX||Vanguard Total Stock Market||302,750.75|
|PTTRX||PIMCO Total Return||225,216.39|
|VINIX||Vanguard S&P 500||175,529.09|
|VFINX||Vanguard S&P 500||160,371.66|
|AGTHX||American Funds Growth Fund of America||143,050.30|
|AEPGX||American Funds EuroPacific Growth||128,067.80|
|VGTSX||Vanguard Total International Stock||127,006.24|
|VBTIX||Vanguard Total Bond Market||97,407.80|
|CAIBX||American Capital Income Builder||96,439.96|
|FRIAX||Franklin Income Fund||96,105.10|
|AMECX||American Funds Income Fund of America||95,102.80|
|CWGIX||Capital World Growth||89,425.39|
|VTBIX||Vanguard Total Bond Market||81,828.84|
|FUSEX||Fidelity Spartan S&P 500||75,923.15|
|ABALX||American Funds Balanced||75,626.44|
|AWSHX||American Washington Mutual Investors||74,519.69|
|AIVSX||American Funds Investment Company of America||74,219.55|
|TPINX||Templeton Global Bond||72,490.00|
Of the top 20, seven are index funds, and eight are active funds run by Capital Research & Management, the parent company behind the American Funds. Sure, the Pimco Total Return Fund run by Bill Gross is the biggest actively managed fund, but American Funds is the heart and soul of old-school stock-picking active management.
And to be blunt, times have been a bit rough for American Funds.
As Bloomberg pointed out in an expose last year, American Funds shed $250 billion via withdrawals between January 2008 and the end of 2013. By the end of 2013, American Funds went on a bit of a reputation-rebuilding campaign, which has seemed to work. Its funds—like the funds of most old-school active managers—have their good years and bad years.
Perhaps most importantly, American Funds has a sterling reputation with the same important constituents that ETF issuers covet; namely, smart financial advisors. With the horrible 2008 returns data rolling off the five-year performance charts, many of American's flagship funds have come back into the black in the rearview mirror. More to the point, brand surveys suggest they have advisor trust.
And despite recent suggestions it wasn't interested in ETFs, American Funds is now filing to enter the 21st century. As skeptical as I am in general about active management, for the raft of financial advisors who've come to rely on American Funds, this gesture to offer nontransparent active ETFs should be seen as a good thing.
The Blind Trust Structure
The second reason this is a big deal is that it's the de facto checkered flag to see which of the competing structures for nontransparent active ETFs will win. I've written quite critically before about the "Exchange Traded Managed Fund" alternative being proposed by Eaton Vance and its Navigate Fund Solutions unit. It adds a whole new kind of trading to the market and requires significant changes in both authorized participants (APs) and investor behavior. I wasn't sanguine on its chances.
The alternative structure, designed by Precidian Investments, is significantly simpler.
In a nutshell, it solves the transparency problem by putting a blind trust in between the AP and the ETF itself. You want new shares? You give cash to the blind trust, it goes and buys a secret list of stocks, in-kinds them to the ETF, and you get shares at the end of the day at NAV.
You want to redeem shares? You hand them to the blind trust, they get the redemption basket from the ETF, likely sell the securities, and hand you cash back. There are nuances, but that's pretty much it.
The Precidian concept is not without its own issues.
Because the market doesn't know exactly what's in the ETF, players buying and selling such ETFs have to guess at what they can hedge against any exposure they have between now and the end of the day, when creations and redemptions are processed at net asset values (NAVs). This likely leads to slightly wider spreads around fair value, though they'll still likely around that same 15-second distributed iNAV.
The elegance of the system is that nobody has to learn how to do anything differently, except APs making a "risk market" for the shares. But, hey, that's their job anyway.
The Elephant In The Room
While a clear win for the Precidian version of nontransparent active (and likely a sign that the SEC is moving closer to approval on the first batch, an idea strengthened by the fact the filer, Paul Roye, used to run the Division of Investment Management at the SEC), I still have the same reservations I've always had about nontransparent active, and that is that it's active, period.
Whether American Funds or BlackRock or anyone else is successful launching nontransparent active ETFs will have less to do with whether the structure works and a lot more to do with whether a particular flavor of active management actually delivers superior risk-adjusted returns over tried-and-true index management.
But then again, I guess that's how it should be, and how ETFs have always made things.
ETFs, as a structure, should really be about getting the structure out of the way. I still think low-cost indexing is probably a better solution for most investors, but I welcome the rest of the investment management world into our little pond in the sea of mutual funds. Come on in, the water's fine.