Eaton Vance received SEC approval late last year to launch a series of actively managed, non-transparent products that will mirror the firm’s mutual funds while combining attributes of ETFs and mutual funds. This latest innovation, known as an Exchange Traded Managed Fund (ETMF), fuels speculation about the entry of other well-known mutual fund firms into the ETF business.
Active ETFs aren’t a new thing, as firms such as PIMCO, First Trust and Wisdom Tree are quick to point out. However, bond and currency ETFs dominate the active ETF category, and firms with a heritage of success managing active equity mutual funds have for the most part held back from offering ETFs.
It’s likely that Eaton Vance (EV) will be the first of many well-known firms to offer actively managed ETF-like products. Just this week, the SEC announced it will likely approve an application from American Funds to launch a series of such products by Feb. 27, while Mario Gabelli’s GAMCO Investors (GBL) said it will file with the SEC to sell ETMFs under its NextShares brand.
Consequently, in this posting we’ll discuss recent developments, while offering a general framework for how to evaluate what is likely to be a steady flow of new products.
Looking for a Competitive Edge
I began writing this article in Boston shortly before the Super Bowl, preparing to go to the game with my wife, a lifelong Patriots fan. Pre-Super Bowl stories about deflation in the Eurozone were replaced by conspiracy theories about deflation of footballs, though now we know that the Patriots thrillingly beat the Seattle Seahawks in Super Bowl XLIX.
There are parallels between investing and sports, as in both arenas participants try to find advantages inside and at times outside the rules. In sports, it can involve modifications to equipment or playing fields, or advance knowledge of what the other team is going to do. In investment management, it’s not all that different.
From the early days of Wall Street, investors have sought information about the trading activity of large investors, looking at a wide variety of information to identify opportunities to trade ahead of large blocks of stock. Michael Lewis recently wrote about high frequency traders tilting the playing field in their favor, by getting trading information milliseconds ahead of other market participants.
ETFs in traditional form offer complete transparency, with market participants having real-time visibility into the underlying holdings of the ETFs. The first generation of actively managed ETFs offer full transparency as well, with real-time visibility seen as less of a negative for portfolio managers managing index funds or bond funds.
Traditional equity managers, particularly those who hold large positions in companies, have been interested in actively managed ETFs but to date have been reticent to be first movers out of fear that they would telegraph their buying and selling intentions to Wall Street traders. In that context, it makes sense for the large active equity managers to want an ETF structure that maintains portfolio holdings confidentiality, reporting holdings only monthly like a traditional mutual fund.
The Eaton Vance ETMF structure and competing approaches from the likes of Precidian and BlackRock (BLK) are attempts to provide other benefits of the ETF structure – continuous trading, low expense ratios, tax advantages – while preserving the confidentiality of the mutual fund structure.
A Less Precise Process?