Imagine being the head coach of a football team. You draw up a playbook with innovative schemes and strategies. You even set the order in which the first 20 plays will be called. And then you have to hand the playbook over to your opponent a day before the game! Now that doesn’t seem fair does it?
Well that essentially was the predicament that active exchange-traded fund (ETF) managers were in since these investment vehicles began to skyrocket in popularity. But that may be about to change dramatically thanks to a recent SEC ruling (technically referred to as exemptive relief). Active ETF managers no longer have to tip their hands and reveal the various components that make up their ETF baskets; they can keep their playbook hidden from the public – and the competition – in a “nontransparent” ETF.
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Structuring a nontransparent ETF
The SEC approved the nontransparent ETF model because it was structured in a way that satisfied two key principles:
The nontransparent ETF method that the SEC approved, referred to as the Precidian model, called for the ETF to appoint a “trusted agent” who has access to all of the ETF portfolio holdings. This allows the trusted agent to accurately price the ETF shares and support market liquidity.
Because the portfolio make-up is kept confidential, other trading firms are prevented from “front-running” and bidding up the price of the underlying securities or other assets before the nontransparent ETF can buy them. And just like a mutual fund, the public is made aware of ETF holdings on a quarterly basis.
Top four things fund managers should anticipate
Regardless of whether you’re currently managing a passive ETF, mutual fund, alternative investment or hedge fund, or are just breaking into the ETF space, here are some things to consider before forming and operating a nontransparent ETF:
Keys to scoring with an ETF
While there are no guarantees for ETF success, there are steps to take that may increase the likelihood of scoring a touchdown:
Executing an effective two-minute drill
It’s anticipated that nearly all active fund managers will at least consider offering their active investment strategies as ETFs, and many have already started the process. So if you’re thinking about entering the nontransparent ETF market, you’ll want to move quickly and put your plan in place before the space becomes too crowded.
“Time is of the essence. Waiting even 18 month may to too late,” cautioned Penman. “The special ETF market you’re targeting may be saturated by then.”
So it’s time for you to go into the two minute drill. This means determining how to best structure your nontransparent ETF so it’s well-positioned to gain SEC approval, line up your service providers and distribution channels, determine who your potential investors are, and formulate your marketing plan.
Being the first to market with a new ETF asset class or industry sub-sector can work to your advantage and help you potentially take a leading position in that investment strategy.