As we discussed different ways in which the actively-managed ETF structure could be improved, one of the biggest concerns that was recognized had to do with the degree of disclosure required by actively-managed ETFs in the US. Active ETFs in the US are regulated such that issuers and managers need to provide complete disclosure of their holdings with a 1-day lag. The problem that creates for managers and the resulting reluctance of issuers to enter the Active ETF space is significant as managers fear their portfolio strategies being copied and front-run, as voiced by several major names like PIMCO and Janus Capital highlighted in the article.
Reported by Bloomberg, BlackRock iShares – by far the largest issuer of ETFs in the world – is now seeking approval from the SEC for actively-managed ETFs "that would keep some of their assets undisclosed". If such a modification to the Active ETF structure gets approved by the SEC, many issuers and managers would be much more comfortable in bringing strong active managers to the Active ETF space without fear for their strategies being front-run. In more than 2 years of existence, the Active ETF space has not seen the arrival of big name active managers operating funds within the ETF wrapper. Only very recently has there been some promise of that changing, with Grail Advisors forming a partnership with DoubleLine which is lead by the illustrious Jeffery Gundlach, a fixed-income manager who is spoken of in the same company as Bill Gross. However, even then, the actively-managed emerging market bond ETF that Grail and DoubleLine have filed for does not have Jeffery Gundlach's name behind it. Given that emerging market bond strategy is the only one within DoubleLine that is not currently lead by Jeffery Gundlach provides the hint that even DoubleLine wants to evaluate the success of their first product before putting its star manager behind a new Active ETF. If the modification in structure proposed by iShares comes to pass, that would definitely go a long way towards providing confidence to star managers that their investment know-how and trading strategies will not be "given away" at the end of each day.
SEC's Concern
The head of SEC's investment-management arm, Andrew Donohue, mentioned in the Bloomberg piece that he was primarily concerned about disrupting the process that "keeps a fund's per-share net asset value and share price closely aligned". This is a genuine concern because if fund disclosure was to happen less frequently, then the market maker who has the responsibility of arbitraging to keep the ETF price close to NAV will have difficulty in doing that effectively. Without knowledge of what the fund's holdings were on the previous day, the creation/redemption process – the means by which the arbitrage process occurs – will likely be hampered as the market maker would be operating with a stale view of the fund's composition.
Learning From Neighbours?
As was proposed in this article, a good idea might be to pick up a few regulatory insights from other countries and how they regulate actively-managed ETFs. In Canada, Active ETFs are not required to provide daily disclosure of holdings. In fact, the leading provider of these products in Canada, Horizons AlphaPro, discloses holdings only once a month, which is still better than most mutual funds. However, they provide complete disclosure of the fund to the ETF's market makers so that they have all the information they need to make markets and minimize the discount/premium of the ETF share price from NAV. So that's a framework worth considering by the SEC – providing complete but confidential disclosure of the fund holdings to the market maker or AP on a daily basis while providing public disclosure with a lower frequency in order to safeguard the manager's value proposition.
Fundamental Difference
Looking at the bigger picture, there is a fundamental difference in how actively-managed ETFs have been evaluated by regulatory bodies in the US versus those in Canada that has resulted in the policy requirements for each. In the US, Active ETFs have been seen as "ETFs" first and actively-managed funds second. Hence, the US requirement to provide daily disclosure of holdings as is the norm for all other ETFs. In Canada, they are considered first to be actively-managed funds and are thus regulated in much the same way that active mutual funds are regulated in Canada.
How this debate plays out will be very interesting to see and the approach that the SEC takes to regulate actively-managed ETFs in the US will likely have huge ramifications on the attractiveness of these products to issuers and renowned active managers. BlackRock iShares, being the biggest ETF issuer, has already lead the way in bringing up the issue with the SEC. If the SEC decides to address these concerns, it could be a big win for the Active ETF issuers.
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