| NEW YORK
NEW YORK Dec 13 Exchange-traded funds have
traditionally been touted for their transparency, with their
portfolio holdings disclosed daily. But the push for a new breed
of ETFs that can hide their specific holdings for months at a
time is gaining momentum.
Several large asset managers, including BlackRock Inc
, State Street Corp, and Eaton Vance Corp have
asked the U.S. Securities and Exchange Commission to let them
market actively managed ETFs that would be permitted to report
their portfolio holdings quarterly. That would put their
reporting requirements on par with traditional mutual funds.
Firms say these so-called "non-transparent" ETFs will allow
them to use sophisticated investment strategies without having
to reveal the fund manager's secret sauce. The SEC currently has
proposals from at least seven firms under consideration, and
many others are on the drawing board.
Some of these funds could launch as early as 2014, if the
SEC grants approval. "It's certainly one of our highest
priorities," said Laura Morrison, who heads exchange-traded
product trading and listing at NYSE Arca, the New York Stock
Exchange's trading platform which has the lion's share of
U.S.-listed ETFs. She told Reuters that NYSE Arca is staffing up
to work with potential issuers and has been in active
conversations with the SEC, market makers and several large
issuers about bringing the funds to market.
THE CASE FOR NON-TRANSPARENT ETFs
All ETFs currently on the market, including so-called
"active" ETFs run by managers as well as the more common
index-tracking funds - are required to disclose their underlying
holdings on a daily basis.
This allows the funds' market makers (large investors who
trade to stabilize share prices) to make trades that keep the
fund's share price in line with the value of its underlying
assets. But for actively managed funds, which often gain a
reputation based on a manager's winning investment philosophy,
daily transparency could allow others to "front-run" the active
"You don't want everyone and his brother knowing what
changes you made in your portfolio so they can front run you,"
said Gary Gastineau, who developed several patents for proposed
ways to enable non-transparent ETFs.
Some of those patents have been used in filings by Eaton
Vance, which purchased his firm, Managed ETFs LLC, and its
One key element proposed by Gastineau is to allow market
makers to base their buy and sell decisions on the fund's net
asset value (NAV) at the end of the day, even though individual
investors would still be able to trade the ETF throughout the
day on the open market. A fund's NAV is based on the closing
prices of the fund's underlying securities at the end of each
trading day, so it would help the market makers understand the
value of the ETF's portfolio without knowing exactly what was in
Precidian Investments, a Bedminster, New Jersey-based ETF
intellectual property shop and industry consultant, is another
firm that has developed patented ideas for opaque ETFs. They
have been used in filings by large firms including BlackRock and
State Street. BlackRock declined to comment on the filing
currently under review. A spokesman for State Street was not
immediately available for comment.
Stuart Thomas, a principal at Precidian, said he views
non-transparent active ETFs as the successor of traditional
mutual funds - essentially combining the low cost, intraday
trading and tax efficiencies of an ETF with the strategic
approach of mutual funds.
"We're not changing the way you manage your fund - you will
still have the ability to do everything you do today," Thomas
The Precidian model includes a "blind trust" through which a
market maker or authorized participant could execute orders,
without the manager having to disclose the fund's holdings on a
"I like the fact that there's competing structures, that
everyone is trying to solve the same problem," Thomas said.
DISTRIBUTION, MARKETING THE NEXT BIG HURDLE
The next big challenge for ETF providers hoping to create
these funds may be finding a way to attract investors, suggests
Dave Nadig, chief investment officer at San Francisco-based
"We're in a market now where distribution is what's driving
assets," Nadig said. He said he believes the technical issues
have been resolved and the SEC will greenlight the funds. "My
concern is more about the marketing," he said.
For that reason, Nadig expects it will be at least a couple
of years after they launch before such funds actually start to
gain any significant market share. And the early participants
will likely be limited to the very large firms with established
"For someone to be successful and garner assets here, I
think they would have to be a Fidelity Contrafund, or
Magellan, or a Growth Fund of America-type of product,
or a Gabelli," Nadig said, referring to funds with strong track
records and followings, or else have "substantial marketing
prowess behind them."
If and when the SEC grants approval for firms to be able to
launch such funds, the ones that follow will have to be approved
before they can begin trading - a process that can already be
lengthy, especially for funds that are considered more exotic
than plain vanilla index-tracking ETFs.
"Each fund would have to go through its own order the way
they do now," said Kathleen Moriarty of Katten Muchin Rosenman
LLP a longtime ETF industry attorney who was involved in the
development of State Street's original SPDR funds. "That's just
the nature of the beast of the way the approval process goes."